Kitces.com - Advancing Knowledge in Financial Planning

Giving Referral Thank-You Gifts That Actually Make Someone Happier

November 20, 2017 07:01 am 2 Comments CATEGORY: Client Trust & Communication

Stearman Biplane Ride and Barnstorming Show For One

Receiving a new client referral has a substantial value for a financial advisor – so much that advisors often provide “thank-you” gifts, either as a simple expression of gratitude, or even as a means to encourage more referrals. Of course, regulators want to be certain that advisors don’t inappropriately “buy” prospective client referrals – in a conflicted or undisclosed manner – and consequently FINRA Rule 3220 limits client gifts to just $100 per year, and the SEC similarly expects RIAs to establish their own gift-giving (and gift-limiting) policies. Nonetheless, the fact remains that referral “thank-you” gifts are relatively common.

Except often the biggest challenge of giving a good referral thank-you gift is simply picking the “right” gift – something that is commensurate with the value of a referral (not too big nor too small), is appropriately personalized and relevant to the recipient, and will likely be appreciated and well-received by the referrer. Which for some advisors, is so stressful that it’s actually easier to give nothing at all – beyond perhaps a simple verbal statement of “thanks” – than risk giving the “wrong” gift.

Yet recent research on happiness suggests that the best thank-you gifts might not actually be giving a “thing” at all, but instead gifting an experience, or giving someone an opportunity to themselves spend on others. And in the modern digital age, a growing number of online platforms make this possible – from online experience-buying sites like Excitations and Xperience Days, to donation sites like DonorsChoose to help teachers fund classroom projects, or even TisBest, which simply sells “charitable gift cards” that the recipient can then redeem as a donation to any one of 300+ charities.

The virtue of such services is that ultimately, it puts power in the hands of the recipient to select the final gift – whether an experience, or a donation to someone else – which helps to reduce the risk of making a poorly-matched gift. But in the end, the true value of gifting experiences or the gifting the opportunity to spend on others is that it increases the likelihood that the recipient will actually feel happier after receiving the gift… which is perhaps the most powerful way to express gratitude for a referral.

Weekend Reading for Financial Planners (November 18-19)

November 17, 2017 02:55 pm 2 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 CFP Board has decided to issue a second draft of its proposed changes to the CFP Standards of Conduct, which is expected to be released in mid-December with a comment period running in January of 2018. Also in the news this week was a new report from PIABA that points out 5 out of the 13 "public" members of FINRA's Board of Governors (who are supposed to represent consumers and have no ties to the industry) actually do have substantive ties to the financial services industry, which raises the significant conflict-of-interest concern that the majority of FINRA's Board is actually comprised of industry representatives (whereas it is supposed to maintain 13-out-of-24 board seats with non-industry public governors).

From there, we have a number of articles on mergers and acquisitions of advisory firms, including a discussion of some of the key factors that drive an advisory firm's valuation (beyond just its size and revenue), what an "earn-out" is and why it's often used as part of the terms of an advisory firm acquisition, and how the ongoing wave of industry consolidation is likely to progress in the coming years as a small subset of mega-firms begin to emerge.

We also have several investment-related articles, from a discussion of how the "p-hacking" phenomenon (of doing so many tests for statistical significance that, ironically, it becomes inevitable that there will be a large number of false positives) may have inappropriate spurred the "investment anomalies" research, a look at the rapid rise and fall of many ETFs (which also appears to be tied to how many ETFs are being launched on spurious anomalies research), and an explanation of how Research Affiliates formulates its own forward-looking return assumptions (important for both portfolio design, and determining reasonable investment assumptions to plug into financial planning software).

We wrap up with three interesting articles, all focused around the theme of financial services industry change: the first raises the question of whether, as the Broker Protocol unravels, if it's time for the SEC to step in and formally codify a version of the Broker Protocol for all firms (broker-dealer and RIA) under Regulation S-P; the second looks at whether it's time to ditch life insurance illustrations and instead demand and require that insurance companies provide more detailed projections (which more clearly explain what are guaranteed costs and what are uncertain assumptions that could be manipulated); and the last suggests that perhaps the best way to fix the compliance woes at broker-dealers is for independent B/Ds to become more stringent on their hiring processes in the first place, vetting prospective brokers and weeding out the bad ones, so that they don't have to create compliance procedures that cater to such a low level "lowest common denominator" broker (to the detriment of all the rest of the good and honest advisors at the broker-dealer). Which is especially important in today's environment of broker-dealer consolidation, where large swaths of brokers – good and bad – may be getting absorbed into other broker-dealers in the coming years!

Enjoy the "light" reading!

The Latest Advisory Industry & FinTech Trends From #SchwabIMPACT

November 16, 2017 02:36 pm 3 Comments CATEGORY: Technology & Advisor FinTech

While it is becoming increasingly clear that "robo-advisors" are not disrupting human financial advisors, the adoption of robo technology by financial advisors themselves is beginning to shift the competitive landscape... both amongst financial advisors themselves, and the technology vendors who serve them, as the very role and value proposition of financial advisors themselves begins to get re-defined.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, I'm interviewed by Neesha Hathi, Executive Vice President and Chief Digital Officer at Schwab, at the Schwab IMPACT 2017 conference, about the latest advisory industry and FinTech trends – including the Robo 2.0 trend currently rolling through the industry, why Robo 2.0 will spur the rebirth of next generation financial planning software, and why it's the rise of better “small data”, rather than “big data”, that is likely to be most important to advisory firms in the coming decade.

One of the biggest trends rolling through the advisory industry right now is rise of “Robo 2.0”. Robo-Advisor 1.0 was all about companies like Betterment and Wealthfront, which made convenient and easy-to-use tech tools for opening accounts, investing those accounts, and managing them over time, and offered directly to consumers. However, we’ve learned that only a small subset of consumers actually want to buy these solutions directly, while there is a large base of financial advisors who want to use these same tools within their own businesses. As a result, Robo 2.0 tools are focused on facilitating the ability of financial advisors to quickly and easily open investment accounts, get the dollars actually transferred, invested, allocated in reasonable models, and model management tools to make it very easy to allocate and rebalance models along the way. The good news for advisors is that these trends drive efficiencies and lower business costs. But the challenge going forward is that now that all of this can be done with a click of a button, advisors need to find new ways to add value for their clients.

Looking forward a bit further, the biggest change we’re likely to see in the industry 5 to 10 years from now isn’t actually the adoption of Robo 2.0 tools, but instead, the rebirth of next-generation financial planning software as investment management receives less attention. As advisors are forced to focus on other areas of financial planning – everything from HSAs and healthcare conversations, to debt management issues, and cash flow planning more generally – advisors are going to need better financial planning software tools to help clients with these issues. Which presents a huge opportunity for those who are interested in building tools oriented towards financial planning, and advisors who want to focus more on financial planning... while for those still mostly focused on investments, the next decade is going to present more of a competitive business challenge.

Another trend that many have predicted will influence the next decade is artificial intelligence, machine learning, and big data. But I’m very skeptical about the discussion of these technologies coming into advisory businesses. Because the reality is that so many of the challenges in what we do for clients are not big data problems. Instead, it’s small data – i.e., the uniqueness of every advisory firm and the clients they serve – where better insights are needed. So while there will certainly be some applications for large firms to leverage big data and bring insights on the entire industry, at the advisor level, the most exciting advancements are in the small data areas that are directly relevant to firm owners and their clients. For instance, automated business management and benchmarking data that makes it easier to track the components of business growth and performance, and tools that automate the many business management reporting processes that advisors are manually doing today.

The bottom line, though, is simply to recognize that we’re in the midst of some big FinTech trends within the advisory industry right now. So if you are an advisor who wants to stay relevant and continue to add value to your clients in the future (or a tech provider who wants to make the tools to help advisors do so!), it is important to understand how these trends will shape financial planning in the future!

Financial Planning Research Highlights From The 2017 Academy of Financial Services Annual Meeting

November 15, 2017 07:01 am 0 Comments CATEGORY: General Planning

From October 1st through October 3rd, the Academy of Financial Services’ annual meeting was in Nashville, TN – partially overlapping with the FPA’s BE Annual Conference. The event brought together many academics and practitioners to share and discuss research, with the intention of increasing academic-practitioner engagement by holding two of the largest conferences for both researchers and practitioners in conjunction.

In this guest post, Derek Tharp – our Research Associate at Kitces.com, and a Ph.D. candidate in the financial planning program at Kansas State University – provides a recap of the 2017 Academy of Financial Services Annual Meeting, and highlights a few particularly studies with practical takeaways for financial planners.

The 2017 Academy of Financial Services (AFS) Annual Meeting showcased research from scholars at a wide range of institutions – with first author affiliation on paper and poster sessions representing roughly 40 institutions. As expected, the core financial planning programs had a strong presence, with scholars from just seven of those institutions serving as lead authors for more than 50% of all research presentations and poster sessions.

The AFS annual meeting featured research on a number of different topics. Some notable sessions for practitioners ranged from topics such as whether having resources from friends and family reduces a household's willingness to establish an emergency fund (not as much as you might expect!), how bull and bear markets impact the subjective assessments of portfolio risk, the links between certain types of personality traits and likelihood of financial stress, and quantifying the financial advisor's value when it comes to making efficient investment decisions (and how that value varies depending on the investor's existing capabilities in the first place).

Overall, holding the AFS Annual Conference and FPA BE Conference in conjunction appeared to be successful in creating greater engagement between practitioners and researchers (with some research presentations filling large rooms at standing room only capacity!). As both the AFS Annual Conference and CFP Board's Academic Research Colloquium strive to create more robust platforms for sharing and engaging in academic research, the future appears bright for financial planning researchers (and research that can really be used by financial planning practitioners)!

#FASuccess Ep 046: Training Financial Advisor Empathy And Communication Skills Through The CeFT Designation with Susan Bradley

November 14, 2017 07:01 am 1 Comment CATEGORY: Financial Advisor Success Podcast

Welcome everyone! Welcome to the 46th episode of the Financial Advisor Success Podcast!

My guest on today's podcast is Susan Bradley. Susan is the founder of the Sudden Money Institute, which trains financial advisors in how to improve their empathy and communication skills when working with clients who experience so-called "Sudden Money" transitions – whether from a business liquidity event, a personal injury settlement, an inheritance, or the settlement proceeds of a divorce. Because as Susan puts it: "When life changes, money changes. And when the money changes, life changes." Which means as advisors, we need the training in how to help clients through those change transitions - which Sudden Money Institute teaches through a designation program called the CeFT (short for Certified Financial Transitionist).

In this episode, we talk in depth about what it really means to help clients through these kinds of financial transitions, why it requires a unique skillset to help people through what is not only a big financial change but typically the major life transition that inevitably accompanies it, the "Purpose, Method, and Outcome" framework that Sudden Money Institute uses to have productive conversations with clients, why it's ineffective to help people in transition to plan for their goals (because they usually don't even know what's possible after a major life transition!), and why it's important to give clients a "decision-free zone" after a major transition before they actually implement any new financial planning strategies.

We also talk about why it is that helping clients through financial transitions really requires more specialized training, the reason that Susan decided to create a formal advisor designation specifically to train advisors in a better and more consistent process, why the CeFT is positioned as a "post-CFP" designation - as you need 5 years of client-facing experience, and an advanced technical designation like the CFP or CPA/PFS, to even qualify for the CeFT training - and what it really takes to complete the year-long training program.

And be certain to listen to the end, where Susan shares her vision of the future value proposition for financial planners, which is all about developing in two directions at once by pursuing post-CFP training, including the technical competency skills that are necessary to actually give the best financial advice, and the empathy and communication skills necessary to really listen to clients and get comfortable being their thinking partner and their guide (and NOT just "the expert" that tells them what to do to achieve their stated goals).

So whether you’ve been looking for better ways to assist clients through financial transitions, thinking about pursuing post-CFP training in communication and empathy skills, or are interested in the evolution of more behavior-change-oriented financial advisor value propositions in the future, I hope you enjoy this episode of the Financial Advisor Success podcast!

Why Performance And Fulcrum Fees Are Banned For Most Financial Advisors

November 13, 2017 07:01 am 7 Comments CATEGORY: Practice Management

As financial advisors feel increasing pressure to differentiate themselves, a recently emerging trend for those who (actively) manage client portfolios is the idea of charging clients not an AUM fee that is a percentage of assets, but instead, a performance-based fee that is a percentage of upside (or outperformance of a benchmark index), where the advisor’s fee is forfeited if he/she fails to achieve the required threshold or hurdle rate. Such a compensation structure would compel active financial advisors to eschew closet indexing and really, truly, try to outperform their benchmarks – which can be a very compelling proposition to prospective clients.

However, the reality is that performance fees have a very troubled past. Because while a performance-based fee does incentivize the advisor to not be a closet indexer and own a substantially different portfolio than the benchmark, one of the “easiest” ways to do so is simply to take on more risk and amplify the volatility of the portfolio. After all, if the markets rise substantially – as they do on average – a high-volatility portfolio will often provide a substantial performance fee in a bull market. In when the inevitable bear market occurs, the “worst case” scenario for the advisor is simply a year of zero fees.

In fact, this “heads the advisor wins, tails the client loses” asymmetry of performance fees is why when Congress created the Investment Advisers Act for RIAs in 1940, it banned most financial advisors from charging performance-based fees at all to retail investors (and of course, brokers under a broker-dealer cannot charge performance fees because they are not serving as actual investment advisers in the first place!). It was only in 1970 that Congress partially relented and allow RIAs serving as investment managers to mutual funds to charge performance fees, and only then if it was a “fulcrum fee” where the advisor participates in both the upside for outperforming and at least some of the downside for underperformance. In turn, it wasn’t until 1985 that the SEC began to allow RIAs to charge performance fees in certain situations to retail clients, and even then the offering must be limited to “Qualified Clients” who meet one of three financial tests… either: a) $1M of assets under management with the RIA charging a performance fee; b) a $2.1M net worth (and thus are presumed to be financially experienced and “sophisticated” enough to understand the risks inherent in performance fees); or c) be an executive officer, director, trustee, or general partner of the RIA, or an employee who participates in the investment activities of the investment adviser.

In addition, it’s notable that research over the years on incentive fees in the context of mutual funds has failed to find any sign that incentive fees are actually associated with better risk-adjusted performance anyway. Instead, the research finds that – perhaps not surprisingly, given the problematic history of performance-based fees – mutual fund managers compensated by incentive fees tend to just generate higher returns by taking more risk, and then amplify their risk-taking activity further once they fall behind their benchmarks! Ironically, though, the researchers did find that mutual funds with incentive fees are more likely to attract client assets, suggesting that substantial consumer demand remains for paying investment managers via performance fees!

Nonetheless, the real-world operational challenges of executing what would be a more complex billing process, the revenue volatility that financial advisors introduce to their businesses (particularly if they use a fulcrum fee structure which means if the advisor underperforms, they really do take the risk of seeing their fees cut substantially), the limitations of only offering a Performance Fee structure to affluent Qualified Clients in the first place, and the conflicts of interest that must be managed, suggests that a widespread shift towards performance fees for RIAs is not likely in the near future… especially as many firms seek to shift their value propositions away from being centered around the investment portfolio and towards financial planning and wealth management instead! But for those RIAs who want to pursue charging performance fees on investment portfolios, it is an option… at least for their Qualified Clients who want to take the risk!