Nerd's Eye View blog

Should Financial Planners Invest Using Bucket Strategies Or Just Report That Way?

May 15, 2013 11:07 am 10 Comments CATEGORY: Investments

Financial planners have always sought to adjust their strategies and communication techniques to the realities of client needs, although the increasing volume of behavioral finance research is now beginning to document exactly how we as human beings sometimes think in very irrational ways, which in turn provides insight about how to best adapt to deliver effective advice. One common challenge area regarding investments in particular is our tendency for mental accounting - where we break up and categorize assets based on various needs and purposes, even if the underlying investments are flexible or entirely fungible - which in turn has spurred the growth of so-called "bucket strategies" that seek to allocate portfolios based on various goals, needs, or time horizons.

Unfortunately, though, recent research has shown that stringent applications of bucket strategies can potentially result in less optimal retirement outcomes, not better ones, particularly due to the "cash drag" and portfolios that can dial down too conservatively too fast; in addition, the reality is that mathematically, most of the benefits of bucket strategies are captured simply from traditional rebalancing strategies, which already ensure that stocks are bought (not sold) when they're down and that cash and bonds are used for spending needs when appropriate.

Nonetheless, from the behavioral perspective, using bucket strategies remains appealing, if only to help clients stay the course during stressful times. But ultimately, perhaps the best solution is not just to weigh the trade-off between managing with buckets (even if the results are worse) versus helping clients psychologically (which is still better than having them bail out at the worst of times), but to accomplish both by improving performance reporting to overlay buckets and goals on top of the portfolio. In other words, maybe the key is not that we need to change how we invest for clients, but simply to more effectively frame how we report the results?

CFP Board Considers Going Into Competition With CE Sponsors It Regulates

May 13, 2013 11:03 am 8 Comments CATEGORY: Planning Profession

Last week, leaders from the CFP Board, including CEO Kevin Keller, board of directors chair Nancy Kistner, and chair-elect Ray Ferrara, traveled to the FPA Retreat conference and NAPFA's national spring conference. The purpose of the visit was not just to participate in the conference itself or check out the latest growth of the organizations; instead, it was to gauge support from these gatherings of the experienced planner community for a potential new initiative: the CFP Board is considering whether it should begin to offer CFP Continuing Education (CE) credit to its certificants, going into direct competition with the CE sponsors it is simultaneously responsible for overseeing, in an effort to raise the quality of CFP CE.

Not surprisingly, given the fiduciary focus of both FPA and NAPFA members and the efforts of the respective organizations on the Financial Planning Coalition - which is currently making the lobbying case for why a conflicted organization like FINRA should not be allowed to oversee registered investment advisers - planners from both groups were negative on the proposal, citing the blatant conflict of interest involved if the CFP Board were to compete with those it regulates.

While at this point, the reality is that this is just a preliminary discussion, and not even a substantively drafted proposal issued for comment, it nonetheless raises a more substantive question: is this really the best idea the CFP Board has regarding how to improve the quality of CFP CE, or does this proposal represent a strategic first step towards something more far reaching, like going into direct membership association competition with the FPA and NAPFA themselves? Will the CFP Board back away from the proposal given the nearly unanimous negative feedback thus far, or will it further tip its hand in pursuing a new strategic initiative?

Weekend Reading for Financial Planners (May 11-12)

May 10, 2013 05:05 pm 1 Comment CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's issue starts off with a surprising announcement that the CFP Board is considering a questionable proposal about whether to offer CE credit and go into direct competition with the CE sponsors it regulates (with advisors expressing strong concern about the conflict of interest that entails), along with two articles reporting on advisor trends in the industry, including a continued slide in the total number of advisors and wirehouses in particular, along with a contrasting view that the decline of wirehouses and the breakaway broker trend may actually be quite overstated.

From there, we look at a few behavioral-finance-related articles, including a controversial study suggesting that as many of 93% of financial advisors experienced symptoms of PTSD after the 2008 financial crisis and that the recent rise of tactical asset allocation may be a stress-driven response, a review of another recent study suggesting that the world of a fund manager is also a much more emotionally-driven experience than many might have thought, a discussion from the Journal of Financial Planning about the importance of focusing not just on a client's risk tolerance but also his/her risk perceptions (and the ways those perceptions can be distorted), and a review by Joel Bruckenstein of a new software package called Riskalyze that is aiming to provide a slightly newer way to assess client risk tolerance.

In addition, there are a few technology-related articles, including a reminder of the importance of considering not just software vendors and products and integrations in your technology decisions but also the staff that must implement it, some guidance from technology consultant Bill Winterberg about how to protect your firm and clients against so-called "phishing" attacks, a look at how some RIAs are successfully using social media to generate new clients, and a great article by Dan Moisand suggesting that the "rise of the machines" is not so much a threat against advisors as an opportunity for them to use technology for better efficiency.

We wrap up with an article reviewing recent research from Julie Littlechild, suggesting that just relying on client referrals by just making them satisfied and happy with your services isn't enough, given that surveys indicate 88% of clients are willing to provide a referral yet only 2% actually do provide one that successfully closes; instead, the real key is to create engaged clients who will refer you not because they're satisfied, but because you know how to solve the problems of one of their friends or family in need. Enjoy the reading!

Coverdell Education Savings Accounts Vs 529 Plans For College Savings

May 8, 2013 11:06 am 6 Comments CATEGORY: Taxes

Over the past decade, 529 college savings plans have been the dominant vehicle for those trying to save and invest for college. The combination of tax-free growth, high contribution limits, generally reasonable expenses, and more favorable financial aid treatment than outright gifting money to children through a UGMA/UTMA account, have all added to the appeal. While alternatives have been available - like Coverdell Education Savings Accounts - the appeal was limited, due both to the relatively small contribution limits, and the potential for some of the most favorable Coverdell rules to sunset at the end of 2012 with the fiscal cliff.

With the American Taxpayer Relief Act fiscal cliff legislation making Coverdell accounts permanent, though, it is perhaps time to give them a fresh look. Unfortunately, their contribution limits remain modest compared to both what can be contributed to 529 plans, and simply the cost of college itself, so Coverdell accounts may still only be part of the college savings picture for many clients in the foreseeable future - especially given that many states provide state tax deductions or credits for 529 plans but not Coverdell accounts. Nonetheless, Coverdell Education Savings Accounts represent one of the only opportunities to save tax-free for elementary and secondary school, and in some cases may even be lower cost than 529 plans due to their greater investment flexibility. As a result, it may be time to start considering them more proactively as a potential planning tool for certain client situations.

Managing The Paradox Of Choice In Your Financial Planning Practice

May 6, 2013 11:06 am 4 Comments CATEGORY: Client Trust & Communication

The proliferation of choice in recent years has given consumers more and more financial options, from choosing a 401(k) investment to selecting a long-term care insurance policy, or even identifying a financial planner to work with. While on the one hand the flexibility of choice is appealing, recent research suggests that in reality too many choices may make us so fearful of choosing poorly that it leads us to not choose at all; in other words, the more choices we have, the less likely we may be to select from any of them.

This so-called "Paradox of Choice" has significant implications for financial planners. On the one hand, it presents an opportunity to deliver value to clients by helping to narrow down and simplify the choices, or at least provide them helpful indicators about how to make a selection from amongst a wide array of complex options. On the other hand, it seems that some financial planners may be creating a Paradox of Choice for clients, sometimes by providing them with too many options about how to even work with the planner, instead of keeping the business model simple with a clear value proposition that clients can just take or leave.

The good news is that with some conscious focus, financial planners really do have an opportunity to create value for clients by helping them avoid "analysis paralysis" and drive forward to decisions and actions that improve their financial lives. But getting there may require us to collectively embrace the inherent irrationality we all have, and recognize that in many situations - including what we offer to our clients and how we help them - that offering more may lead to less, and focusing on less may lead to more.

Weekend Reading for Financial Planners (May 4-5)

May 3, 2013 05:01 pm 3 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's issue starts off with a review of the latest Mark Hurley research suggesting that the overwhelming majority of advisory firms still have no economic value and are struggling for profitability. There's also a good review from Bob Veres of the rising range of online startup firms that are threatening advisors in various ways, a look at the recent SEC announcement that many RIA firms are failing to follow the Rule 206(4)-2 Custody Rules for client assets (in many cases, because the firms don't even realize what they're doing triggers the custody rule!), and a summary of recent research finding advisor use of social media - and consumer use of social media looking for advisors - continues to rise, with LinkedIn as the most active platform.

From there, we look at a few recent articles that have been critical of the SEC's request for information to do a cost-benefit analysis regarding a uniform fiduciary standard, finding that the way the SEC is asking the questions may already be shaping the outcome in a manner that either undermines the intended purpose of the rule, or in the view of the Institute for the Fiduciary Standard outright narrows the potential scope of fiduciary to the point where it no longer provides effective consumer protection. There's also an interesting alternative proposal from Don Trone that a better way to bring principles-based fiduciary to broker-dealers is to craft a series of "fiduciary safe harbor" guidelines that would allow broker-dealers to comfortably apply a fiduciary standard and know how to oversee it, without creating a maze of burdensome rules.

In addition, there's an article from Steve Utkus of the Vanguard Center for Retirement Research that criticizes the recent and controversial PBS Frontline special "The Retirement Gamble" (despite the special's favorable positioning of Vanguard and low-cost indexing), and a look from John Mauldin about how the progression to a "cashless society" (where we all do business using credit cards, debit cards, and smartphones) may be further away than we think, due to the rise in cash-based economic activity due to the incentives created by regulation, taxation, and social programs.

We wrap up with three very interesting articles: the first is a review of the recent "Technology Tools for Today's High-Margin Practice" book by Bruckenstein and Drucker; the second looks at a behavioral bias called "motivated reasoning" - where we are more analytical and critical of things that would challenge our existing views and beliefs - that can be a challenge for both clients and advisors themselves; and the last looks at how the shift to 401(k) and other defined contribution trends is analogous to a broader societal shift towards a greater demand on self-motivation and self-reliance, which allows some to flourish but is creating significant challenges for many others, as a world with more choices and fewer limits also has fewer guarantees and safety nets... and perhaps more opportunities for advisors to help people navigate effectively. Enjoy the reading!

Is Capital Loss Harvesting Overvalued?

May 1, 2013 11:01 am 27 Comments CATEGORY: Taxes

Capital loss harvesting has long been a staple of investment tax strategy - so much that the Internal Revenue Code has special "wash sale" rules to ensure that the technique is not overly abused. Fortunately, though, the wash sale rules can be navigated effectively, allowing taxpayers some means to take advantage of available tax losses.

However, while tax loss harvesting remains a viable strategy, it is often greatly overvalued, as the true benefit is not the tax savings from harvesting a loss but merely the benefit of deferring those gains. In the meantime, the strategy has a non-trivial exposure to several risks, including the potential for the alternative investment held during the 30-day wash rule period underperforming the original investment, the possibility of negative tax arbitrage if the investment rebounds in the near term, and the danger that harvesting losses too effectively over time will drive the client's future capital gains into a higher tax bracket! In addition, the fact remains that capital loss harvesting produces no benefits for clients who are eligible for 0% capital gains tax rates, and in fact potentially harms them; in such scenarios, clients should actually be harvesting gains, not losses!

Ultimately, this doesn't mean that harvesting capital losses is a bad strategy, but it is a strategy where the risks must be carefully considered, as they can easily outweigh the relatively modest benefits!
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Why Aren’t Checklists A Financial Planning Standard?

April 29, 2013 11:03 am 155 Comments CATEGORY: Practice Management

As financial planning for clients grows more and more complex, it becomes increasingly difficult for planners to recognize every planning issue, opportunity, and concern from memory alone. As a result, there is an rising risk that planners commit malpractice and make a mistake - albeit by accident - in the struggle of trying to apply everything they have learned to an incredibly wide range of client situations.

However, the reality is that this challenge is not unique to financial planning. Many professions face a similar struggle, where the sheer amount of knowledge required, and the incredible number of client/customer/patient situations make it almost impossible to remember everything that's necessary at the exact time it's needed, mean a rising risk of mistakes, negligence, and ineptitude.

So what's the solution to address this challenge? As it turns out, there's a remarkably simple one: checklists. While it may seem absurd that such a basic device could enhance client outcomes - in fact, as professionals we often bristle at the thought that a checklist could tell us something we don't already know - it turns out that checklists may be an excellent means to deal with the simple fact that we are all fallible humans.

Unfortunately, though, few checklists currently exist in the world of financial planning, especially outside of the operational aspects of an advisory firm. Nonetheless, it is perhaps time to give checklists the recognition they deserve, as a potentially critical step to ensure that we apply the proper due diligence to each and every complex financial planning situation, and that nothing accidentally slips through the cracks.

Weekend Reading for Financial Planners (Apr 27-28)

April 26, 2013 03:15 pm 3 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's issue starts off with some breaking news about the announcement by Senator Baucus that he will not run for re-election in 2014 - which may set the stage for compromise on bipartisan tax legislation - and a look at the latest in the recent debates about the flaws in the Reinhart and Rogoff research on high-debt countries, which are now suggesting that the criticism may have overstated the issue and that the fundamental concerns of growth in high-debt countries remain.

From there, we look at a few articles on working with younger "next generation" planners, including a discussion of the FPA's rising focus on young planners, some guidance from Deena Katz on how to better bridge the baby boomer vs Gen X/Y gap (which she suggests requires some improvements from both sides of the chasm), some tips on how to recruit and hiring Generation Y advisors and get them to stay, and some advice from Angie Herbers on when to consider not just hiring young "professional" staff (meaning young financial planners) but also "non-professional" staff (meaning your high quality operations and administrative staff) who can also have a critical impact on the success of your business.

In addition, there are two articles regarding social media, including one that looks at a series of recent research studies showing the rising adoption of social media by both advisors and their prospective and current clients, and another that examines the rising conflict between regulatory efforts to oversee social media in financial services and states enacting laws to protect personal social media accounts from employers. There's also an article by Mark Tibergien cautioning advisors not to just be "Fiduciaries In Name Only" (or "FINO" for short!), but to ensure that the entire practice is really being run in a proper manner.

We wrap up with three very interesting articles: the first is from retirement researcher Moshe Milevsky about whether we should consider bringing back an old annuity-like pooled investment approach called a tontine; the second looks at how to generate better referrals by getting your clients not to tell their friends about you and your benefits but a story about the kinds of problems you help people solve; and the last provides a good reminder that while all the technical knowledge we apply for our clients is valuable, from tax strategies to investment management, that for some clients our key value proposition may not be that we do it "better" than the client but simply that we do it "for" them and eliminate their time, hassle, and stress, so they can better enjoy their lives. Enjoy the reading!

Proposal Threatens To Ban Specific Share Identification Method For Lot Level Accounting Tax Strategies

April 24, 2013 11:04 am 6 Comments CATEGORY: Investments

The specific share identification method allows investors to choose which investment is sold, which can be especially helpful when there are multiple lots purchased over time that each have a different cost basis, as advisors and their clients have the opportunity to identify exactly which shares to sell to get the best tax result. In the past, this strategy was implemented to maximize tax loss harvesting to minimize an individual's tax liability over time, although notably in today's world some advisors and clients are actually using it to ensure that long-term capital gains are harvested for those in the bottom tax brackets! Either way, though, specific share identification provided the planning opportunity, and in fact a popular feature of portfolio accounting and rebalancing software has been the ability to track and manage lot level accounting to optimize these decisions.

The rules for specific share identification were tightened up slightly in recent years, as 2008 legislation has been phasing in year by year that requires brokers and custodians to track the cost basis of newly purchased investments - so-called "covered securities" - and to report the results of sales to the IRS on a new Form 1099-B that provides information on not just the sales proceeds and sale date (as in the past), but also the cost basis, acquisition date, amount of the gain or loss, and character of the gain or loss (i.e., long-term or short-term). In addition, the new tracking rules effectively enforce the requirement that if advisors and their clients are going to use the specific share identification method, or otherwise want to set a favorable default method of accounting, it must be chosen by the time the sale occurs and the trade settles; otherwise, the lot selection is "locked in" and cannot be changed later.

In a new potential blow to the planning strategy, though, the latest 2014 Budget Proposal from President Obama would eliminate lot level accounting and the specific share identification method altogether, requiring instead that covered securities all be reported using the average cost method once they are held long enough to be eligible for long-term capital gains. Although some of the details remain unclear - most notably, whether the rules would apply only for stocks, or for mutual funds and ETFs as well - the bottom line is that the opportunity to make tax-savvy decisions about individual investment lots being sold may soon cease to be a value proposition for advisors and the technology that supports them!