Kitces.com - Advancing Knowledge in Financial Planning

Why “Endowment-Style” Donor-Advised Funds Should Be Allocated More Aggressively

May 30, 2018 07:01 am 2 Comments CATEGORY: Investments

College & University Endowment Account Allocation by Endowment Size

Donor-advised funds (DAFs) are flexible tools which can be used for a number of charitable giving purposes. One increasingly popular use is to use an "endowment-style" DAF in lieu of a private foundation for those with charitable intentions of leaving a legacy that will continue to have an impact on the world many years into the future, given that DAFs are cheaper to operate, more tax efficient, more flexible, and eligible for higher limits on tax deductibility of contributions. However, while much attention has been given to how individuals should allocate a portfolio throughout their own lifespan, considerably less attention has been given to the question of how to best allocate a portfolio if one's time horizon is "forever". Especially when it has flexibility with respect to its distributions.

In this guest post, Dr. Derek Tharp – a Kitces.com Researcher, and a recent Ph.D. graduate from the financial planning program at Kansas State University – analyzes considerations when coordinating investment and spending policies of an endowment-style DAF, finding that for donors who have the willingness and ability to be flexible in their distribution policy, investment allocations can be much more aggressive than those commonly adopted by endowments, generating far more income for charitable beneficiaries and build a larger endowment value to sustain giving well into the future.

The traditional approach to investment an endowment is still a well-diversified conservative or moderate growth portfolio - e.g., a 60/40 portfolio - owing in large part to the fact that most endowments have a high need for distribution stability (e.g., university endowment funds that need to fund ongoing operating costs that universities have become highly dependent on). However, in the context of an endowment-style DAF, the reality is that individual donors often have far more flexibility about when and how much they donate. Which is important, especially with the possibility of 100+ year time horizons that allow for immense (and intuitively-difficult-to-grasp) compounding.

In fact, a Monte Carlo analysis (based on historical market returns) of an ultra-long-term endowment-style DAF with a flexible (e.g., percentage-of-assets) distribution policy finds that shifting a fairly modest $100k endowment-style DAF from a balanced portfolio allocation (50/50) to an aggressive allocation (100/0) would result in an extra $13.6 million in inflation-adjusted median endowment account value after 100 years, while also generating an additional $5.6 million in distributions to charitable institutions along the way (albeit with some volatility in annual distributions from year to year)! Further, adopting a simple dynamic spending/distribution strategy (e.g., forego a distribution in years with less than a 2.5% real return), results in an additional $6.1 million boost in real residual value and $1.2 million more in cumulative charitable distributions (as distributions are skipped in some years but made up over time)!

Ultimately, the key point is to acknowledge that willingness to accept some spending instability, coupled with ultra-long-term time horizons to compound, makes it feasible to have a far more aggressive portfolio that still result in substantially more assets going to the charitable institutions that donors care about. Of course, donors must be willing to stay the course, avoid projecting their personal risk tolerance onto the endowment, and be comfortable adopting an allocation that is much more aggressive than the "norm" among prominent endowments... but donors should be cognizant of the tremendous potential of investing more aggressively (and the impact of long-term compounding) if they are willing and able to be flexible!

#FASuccess Ep 074: Why Solo Financial Advisor Success Is All About Self-Confidence In Your Own Value with Diane MacPhee

May 29, 2018 07:01 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Welcome, everyone! Welcome to the 74th episode of the Financial Advisor Success Podcast!

My guest on today's podcast is Diane MacPhee. Diane is the founder of DMAC Consulting, a financial advisor coaching and practice management consulting firm that specializes in solo and emerging ensemble advisory firms.

What's unique about Diane, though, is that before she was a coach for financial advisors, she was a fee-only financial planner herself for 16 years, and as a result brings a unique perspective with both the experience of a financial advisor and the training of being a professional certified coach.

In this episode, we talk in depth about the challenges of being a successful solo financial advisor, the self-limiting beliefs we sometimes inflict on ourselves that prevents us from growing and being as successful as we could be, why it's so hard to set the "right" fee for clients (and especially to raise fees when we should), and why the #1 element to success as an advisor is to really find and get control of your own self-confidence, so you can confidently articulate your value to clients and prospects.

We also talk about strategies to break through when you hit "The Wall" in your practice – that point where you're at capacity with the number of clients you serve, and you can start to feel tired, or overwhelmed, or outright drowning in your own practice – and why eventually, the key to continued success is not about figuring out how to hire more staff or use technology more efficiently or new marketing ideas to grow and add more clients, but how to transition to the right clients for you... even if that means it's time for an "amicable termination" from some of your existing clients.

And be certain to listen to the end, where we talk about the key transition to make if you do want to grow into an ensemble practice beyond yourself... which is all about hiring people you can trust, and learning to let go and not be the bottleneck in your own advisory firm. Which, unfortunately, is much easier said than done.

So whether you are interested in learning more about the challenges of being a successful solo financial advisor, are interested in how to identify the right clients for you, or are wondering how you can build a true ensemble firm that extends beyond yourself, I hope you enjoy this episode of the Financial Advisor Success podcast!

Raising AdvicePay Capital And How Misaligned VC Incentives Strangle Advisor FinTech Innovation

May 28, 2018 07:01 am 0 Comments CATEGORY: Technology & Advisor FinTech

Featured Image Growth Multiples And Venture Capital Return Expectations

Starting a business from scratch is a risky endeavor, in which often those who put money into the business never even see a return of their money, much less a return on their investment. Which can be especially damaging for a founder who sinks their life savings into a business idea that doesn’t work out… or worse, doesn’t have enough money to put in to get a good idea for a company off the ground in the first place.

Fortunately, though, venture capital firms exist to help fund these high-risk entrepreneurial endeavors. Because for a VC fund, it’s not necessary for every company to succeed; the venture fund can be profitable in the aggregate and generate an appealing return on capital by diversifying across multiple startups, leveraging the power of diversification and the fact that the high risk also generates a very high return potential… such that 80% of the returns may be driven by only 20% of the companies, or in the extreme almost all the returns may come from just 1-2 “home run” investment opportunities that become huge.

Yet the challenge of this kind of ultra-high-risk-and-high-return investing is that VC funds will often shy away from viable business opportunities that are not deemed to be “big enough” to be the home runs necessary to make up for all the potential losses of the companies that don’t work out. Or alternatively, may invest into companies but push the founders to take more risk than they actually wanted to… as while a “Go Big Or Go Bust” approach may work for a diversified VC fund, it can be ruinous to the founder that has only their one company to be a part of!

The end result of this dynamic, particularly in a limited-size “niche” industry like financial advisors, is that few venture capital firms – even those focused on FinTech – actually have any interest in investing in advisor technology, where most of the “successful” companies may eventually sold for $10s of millions… but not the $100s of millions, or billions, that most VC firms are shooting for. Thus why investing in B2C robo-advisors – with their potential for 100+ million consumer households – was more compelling to most venture firms than funding the equivalent next-generation onboarding-and-rebalancing-software solutions for financial advisors.

In turn, this has driven the overwhelming majority of advisor technology innovation to be limited to what companies can be created for advisors, by advisors, and often funded by advisors as well – in a world where the potential to earn “bad” 15% - 20% returns for a VC fund are still “great” returns for an individual advisor-as-investor (whose primary alternative is the stock market). From Junxure to Redtail, to Orion and Tamarac, iRebal and TradeWarrior and Red/Black, RiskPro and Tolerisk… most advisor technology innovation is advisor funded.

Accordingly, we’re excited to announce that our own AdvicePay payment processing solution for financial advisors is opening an extension to its prior Seed round, raising up to $2M of capital directly from the financial advisor community (at least, those who are eligible Accredited Investors!). Because in the end, it seems the only way that technology will improve for financial advisors is to invest in making it happen ourselves!

Weekend Reading for Financial Planners (May 26-27)

May 25, 2018 02:52 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the news that the 5th Circuit Appeals Court has denied what appears to be the last and final appeal of the states to intervene and defend the Department of Labor's fiduciary rule, in what will probably prove to have been the final effort to revive it (although the court itself still hasn't actually issued their final mandate to vacate the rule after their March 15th decision). On a happier note in the news this week, Focus Financial began the paperwork process to file for an IPO, in what would be the first ever initial public offering of an independent RIA providing wealth management (or at least, a holding company that has aggregated dozens of them together).

From there, we have several tax-related articles this week, including a look at savings strategies for high-income individuals who want to save more above-and-beyond maxing out their 401(k) plans and IRAs, workarounds for families that have (unwittingly?) saved money in grandparent-owned 529 plans and now realize the adverse financial aid consequences of the arrangement, and tips and strategies for estate tax (and broader estate) planning when working with ultra-HNW clients (where it's not just about the technical strategies themselves, but ensuring they are properly implemented to avoid IRS scrutiny, and appropriately communicated to the family to avoid future disputes).

We also have a few practice management articles on attracting and retaining employees, including: new research that what employees want isn't just a progression of Maslow's hierarchy but a combination of 3 core areas (career, community, and cause); why it's a good idea to try customizing job descriptions to individual employees (essentially fitting the job description to the employee, instead of the traditional approach of trying to find an employee who fits the job description); tips for handling underperforming employees; and why some advisory firms are exploring new employee benefits like month-long sabbaticals to attract and retain top talent.

We wrap up with three interesting articles, all around the theme of the advisor's role in not just providing advice and recommendations to clients, but helping them actually implement the advice: the first looks at how coaches often command much higher fees than advisors (because people will pay 'something' for good advice and expertise, but even more for someone that helps ensure they actually get it done!); the second looks at how the research on trust in professionals (including advisors) isn't just about demonstrating the advisor's competency and expertise, but his/her "warmth" and caring (because client's won't implement the advice if they don't believe it's really in their best interests); and the last draws on Dr. Moira Somers' new book "Advice That Sticks" and the research from the medical industry on what leads to patients actually adhering to the advice and prescriptions their doctors provide... and what advisors can learn from it about how to make our own advice "stick", too!

Enjoy the "light" reading!

Why RIA Custodians Should Start Charging A Basis Point Custody Fee

May 24, 2018 01:41 pm 0 Comments CATEGORY: Practice Management

A custodian is one of the most crucial vendors for RIAs that manage client assets. From the core custodial services of trading and holding and keeping records of electronically-owned securities, to the ancillary technology that custodians provide to help advisors run their business, a good RIA custodial relationship can help firms attract and retain clients. However, as the advisory industry has shifted from a focus on sales to advice, custodians and the RIAs they serve are increasingly in conflict with one another, as many of the ways in which RIAs can help their clients reduce costs and further grow their wealth (reducing unnecessary trading costs, seeking out the best cash options, etc.) are actually detrimental to the bottom lines of the RIA custodians they use!

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss why RIA custodians should start charging the RIAs they serve a custody fee, and why a basis-point custody fee would ultimately better align the interests of RIAs and the custodians that serve them, allowing custodians to actually focus on providing the best services and solutions to RIAs, instead of just seeking new ways to make money off of an RIA's clients instead!

To better understand why an RIA custody fee would be an improvement relative to the status quo, it is helpful to first look at how RIA custodial platforms actually make their money in the first place. In practice, most RIA custodians make money in three ways: (1) earning money on cash (either through the expense ratio of a proprietary money market fund, or by sweeping the cash to a related bank subsidiary), (2) servicing fees for mutual funds and ETFs, such as sub-TA fees along with 12b-1s via "No Transaction Fee" (NTF) platforms, and (3) ticket charges earned whenever a client makes a trade. In practice, many of these fees may ultimately be trivial to the end consumer (e.g., it's unlikely a 50 basis point fee on a 1% cash position is going to make or break a client's retirement), but when companies like Charles Schwab have almost 1.5 trillion dollars on their RIA platform, these expenses result in substantial revenues for RIA platforms when aggregated across all clients... albeit at the direct expense to the client.

And the reason this structure matters is that it means RIA custodians are fundamentally misaligned with the advisors they serve. Because a situation is created where we as RIAs create value for our clients by trying to systematically dismantle the custodian’s revenue and profit lines! Instead of just leaving cash in whatever money market fund is available, we look for ways to reduce cash balances or shift that cash to institutions that best compensate our clients for holding cash. Instead of using an NTF fund with a higher expense ratio, we'll shift our client's assets to a non-NTF fund when the ticket charge will reduce costs for them (or vice-versa). And unlike broker-dealers who stand to profit from increased trading (by marking up the ticket charges for themselves), RIAs try to reduce trading costs by helping clients avoid unnecessary trading. In short, the problem is that as RIAs, custodians have put us in the position where we look better by sticking it to the custodian... and the more we manage to ‘play the game’ and dismantle the custodian’s profit centers, the more money we save our clients, and the better we look to our clients!

And this is why the future of the RIA custody business will eventually be RIAs simply paying a basis point custody fee to the RIA custodian instead. Which is a huge leap relative to the “free” that we as RIAs currently enjoy with our custodians... but basis point custodial fees would actually be better for all of us in the long run! Suppose RIA custodians charged 10 basis points, tiering down to 7, 5, and then 3 basis points for large firms (intended to simply approximate what they already make off of RIA clients on average). If custodians did this in lieu of making money off of our clients, now their incentive is not to try and figure out how they can make more money off of our clients, but instead to truly create the best RIA custody platform out there for gathering client assets! With a custody fee in place, RIA custodians could then pay better rates on money market funds, eliminate ticket charges that annoy our clients (and time spent by advisors devising ways around ticket charges for our clients), and eliminate both 12b-1 fees and sub-TA fees, instead providing a new version of truly "clean shares" that strip out all back-end fees (regardless of what fund company is used). In other words, once the RIA custodian gets an RIA custody fee, the custodian is freed up to actually give us as advisors the best possible solutions for our clients!

Of course, there may be some challenges in getting RIAs to adopt such a model, particularly given that a subset of RIAs – namely those that use buy and hold portfolios for clients and actively seek ways to get clients the best deal on cash holdings – are already paying less (as they're effectively subsidized by the RIAs that do not use such strategies!).

But the bottom line is just to recognize that, in the long-run, both RIAs and the custodial platforms they use would be better off with custodians charging a basis point custody fee, rather than just looking for ways to make money off of our clients. Even though it may feel really awkward to us when we’re not using to paying that custody fee, it will ultimately be better, both for the custodian and for the RIA itself, by properly aligning their interests… which means, in the end, it’s better for the client, too!

GDPR Compliance Rules For Financial Advisors Engaged In Digital Marketing

May 23, 2018 07:01 am 2 Comments CATEGORY: Practice Management

In recent weeks, you may have noticed a wave of "Privacy Policy updates" coming through your email inbox. What financial advisors, and particularly those of us in the US, may be less knowledgeable of, is what's driving these updates. The answer is the "General Data Protection Regulation" (GDPR), which is a new set of laws that govern internet privacy in the EU, and will go into effect this week on May 25, 2018. And while it may seem that privacy regulation in the EU is irrelevant to US advisors - who are not based in the EU - the reality is that if you have any clients in the EU, you market your services to clients in the EU, or you have clients who will be moving to the EU, then you are subject to GDPR as well! And there is some debate that even merely having EU web traffic that you're tracking on your website could trigger GDPR rules for US financial advisors!

In this guest post, Zach McDonald of Mineral Interactive shares his thoughts on how US financial advisors can remain compliant with EU laws as GDPR goes into effect, including understanding the rights of consumers guaranteed under GDPR (e.g., the right to be forgotten, right to have access to personal data, right to grant or deny services consent, and the right to grant or deny placement of cookies), the advisors potentially impacted under GDPR (including any advisors who work with or solicit clients in the EU, and potentially even those who may merely have EU web traffic), the steps advisors can take to become GDPR compliant (from getting permission to track cookies, to verifying that vendors are compliant, and more), and the tools advisors commonly use that could also create GDPR issues (such as appointment schedulers, landing pagers, and many others)!

Ultimately, though, the key point is to acknowledge that advisors in the US cannot simply ignore GDPR as something that only applies to those in Europe. Many advisors in the US could fall under GDPR, due to something as minor as a single existing client who moves to Europe. And until we see how the EU will enforce the regulations, there is a risk that even just getting EU web traffic (whether the advisor wants it or not!) could trigger GDPR issues. As a result, advisors overlook GDPR compliance at their own risk, as failure to comply with GDPR can lead to substantial EU fines! And given the recent scandals and large-scale breaches of consumer data in the US – such as those at Facebook and Equifax – there's also the possibility that GDPR could simply serve as a bellwether of changes to come here in the US as well! (Which means we may all be subject to GDPR-like rules soon enough!)