asset location

Billing on Outside Held-Away Assets Under Advisement: Issues To Consider

July 26, 2018 12:06 pm 0 Comments CATEGORY: Practice Management

Issues To Consider When Billing On Outside On Held-Away Assets Under Advisement Featured Image

As advisory firms seek to refine their fee structures and find ways to add value for (and generate new revenue from) their existing clients, one of the more interesting shifts in the industry over the past couple years has been away from billing on assets under management and towards assets under advisement, which are those outside held-away assets (e.g., a 401(k) plan at a current employer) on which an advisor may make recommendations, but not necessarily effect any transactions (because it’s not under their direct management). The appeal of such an approach is understandable: qualified plans are an ever-increasing piece of clients’ nest egg, especially for those in their 30s, 40s, and 50s, and the dilemma advisors often face is that, while a potential client might have significant net worth, much of that is tied up in accounts that the advisor can’t manage directly.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss the ways in which advisors are working with clients with substantial held-away assets, the issues they may face when charging an assets-under-advisement (AUA) fee on outside assets, and some operational challenges that advisors need to think about before adding on this type of fee structure.

The quintessential example of a client where an AUA fee may be a better fit than an AUM fee is the still-working client with a moderate (e.g., $150,000) brokerage account, and a sizable (e.g., $350,000) 401(k) plan at a current employer, where the client can afford to pay the advisor a reasonable fee in the aggregate, but not necessarily “just” from the account that’s available to manage.

There are a few ways to handle situations like this. In some cases, the advisor simples takes the client on in hopes of getting that sizable roll-over down the road (even if it’s an unprofitable client for years up until that point). Others may set a minimum annual fee for clients if their available assets fall under a certain threshold, ensuring that there is a sufficient level of revenue per client to service the client, and letting those with sufficient net worth (even if not all available to manage) to decide for themselves whether to move assets, or just pay the fee.

The third approach that’s emerging, though, is simply to not charge only on the assets that the advisor manages directly, but also setting an assets under advisement fee for those outside held-away assets that might provide advice on, even if the advisor doesn’t (or can’t) have discretionary authority. For which the AUA fee is typically lower, recognizing that while the advisor does provide some services, it is less than the full-service management (for the full-service management fee) on the actual managed accounts.

However, charging an AUA fee it’s not without its potential pitfalls. In some cases, clients may not want to pay for “just” asset allocation advice they have to implement themselves. And if an advisor gets the client’s login credentials to do it for them, the service is a lot less cost efficient due to the added layers on manual work involved, and means that the advisor has custody of those assets (and as such, is subject to an annual surprise custody audit under the SEC custody rule). Moreover, if the client gets accustomed to paying a lower fee to have the outside 401(k) “advised upon”, they may not want to roll over and pay a full management fee when the time comes (if the advisor has not effectively distinguished the value). Which can be especially challenging for advisors with a more passive approach, since at least active managers can claim there is additional value in rolling over by being able to implement full investment management process (e.g., offering “tactical management of retirement assets to minimize sequence of returns risk”).

Beyond those challenges, advisors also need to figure out how they’re actually going to bill on those held-away assets. As since advisors generally can’t deduct fees directly from a 401(k) account, they will either have to bill from managed accounts they do oversee (which is bad news for the advisor’s performance numbers, since the fees for the entire pie and coming from just the advisor’s slice), or send the client an invoice and implement technology to bill them directly.

These challenges to adopting an AUA fee aren’t insurmountable, however, but do require some careful thought and planning in advance. As ultimately, charging a fee on assets under advisement may be a good way for certain advisors to expand their relationship with existing clients, especially those who are still in their working years and have a sizable 401(k) plan that is unavailable to be managed directly. However, the AUA fee has got to make sense from a business perspective as well, which means having a clear operational game plan for calculating fees, dealing with all the extra manual work, and for navigating the regulatory minefield.

Calculating Accurate Regulatory AUM Vs Reporting Assets Under Advisement (AUA)

May 10, 2017 07:01 am 7 Comments CATEGORY: Investments

In today’s increasingly competitive landscape for advisory firms, financial advisors are looking for any way they can to differentiate. Whether it’s their experience and credentials, specialization or depth of services, or simply the sheer size of the firm, based on its assets under management. After all, the reality is that – justified or not – a sizable reported AUM does imply a certain level of credibility and represents a form of social proof (the firm “must” be good, or it wouldn’t have gotten so much AUM, right!?).

As a result of this trend, though, advisory firms are increasingly pushing the line in counting – or potentially, over-counting – their stated assets under management. Which is important, because not only is overstating AUM a potential form of fraudulent advertising, but the SEC has very explicit rules to determine what should be counted as AUM (or not) for regulatory purposes.

Specifically, the SEC states in its directions for Form ADV Part 1 that regulatory AUM should only include securities portfolios for which the advisor provides continuous and regular supervisory or management services. And while most financial advisors today are regularly working with clients regarding their investment securities, not all advisors are necessarily providing “continuous and regular” services on their client accounts. In fact, if the advisor doesn’t have direct authority to implement client trades (either with discretion or after the client accepts the advisor’s recommendation), it’s virtually impossible to include the account as part of regulatory AUM.

The greater challenge, though, is that the increasingly common offering of comprehensive financial planning services – where advisors provide holistic financial planning advice on all of a client’s net worth – does not mean the advisor can claim all of those assets as regulatory AUM. In fact, most of the time the advisor should not include outside 401(k) plans and other non-managed assets that were advised upon as part of the financial plan, nor the value of brokerage accounts holding mutual funds and various types of annuities (unless the advisor truly provide ongoing management services), nor TAMP or SMA assets (unless the advisor retains the discretionary right to hire/fire the manager and reallocate to another one). In fact, even having discretion over an account doesn’t automatically ensure it being counted as regulatory AUM, particularly if it’s a passive buy-and-hold account, unless the advisor can actually substantiate that monitoring and due diligence is occurring outside of any ad-hoc or periodic client review meetings!

Fortunately, for advisors who want to report some number representing the total scope of their advice – including the amount of assets that don’t count as regulatory AUM – it is permissible to report on Assets Under Advisement (AUA) in the advisor’s marketing and in Part 2 of Form ADV, as long as the advisor can document and substantiate the calculation process. But the fact that it’s permissible to report both AUM and also a (typically large) AUA amount doesn’t change the fact that, when reporting regulatory AUM itself, it’s crucial to report the right number!

Should Advisors Reduce Their Management Fees On Fixed Income Allocations?

July 7, 2016 08:46 am 11 Comments CATEGORY: Investments

The ongoing decline in interest rates since the financial crisis have been a boon for those looking to refinance a mortgage or businesses looking to borrow, but an immense challenge for investors that rely on fixed income returns, from insurance companies to individual accumulators and retirees. And as bond returns grind lower, it has brought a renewed focus on costs (that eat up an ever-larger percentage of a smaller return), including the question of whether financial advisors should charge less for managing a bond portfolio compared to a stock portfolio.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at the question of whether advisors really should be charging separate and different fees on the fixed income versus equity allocations in a portfolio, including and especially for those who also deliver extensive financial planning services as a part of their AUM fee as well.

Of course, given that the typical bond mutual fund is already less expensive than the average stock mutual fund, arguably the asset management industry has already spoken and suggested that the fees should not be the same. If only because today's low bond yields, plus the more limited volatility of bonds (at least compared to stocks), means there's just only so much opportunity to create active management value in bonds and outearn that fee in the first place.

On the other hand, the reality is that most advisors don't manage just all-bond or all-stock portfolios as a mutual fund does. Advisors typically manage blended portfolios of stocks and bonds, sometimes tactically managing amongst all those asset classes, and an increasingly large portion of the AUM fee is being allocated to financial planning services anyway... which are based on the amount of actual financial planning work to be done, and arguably remain the same regardless of how the portfolio happens to be invested.

And in fact, with the looming Department of Labor fiduciary rule taking effect in April of 2017, charging different fees for stock versus bond allocations may become a prohibited transaction anyway, at least in an IRA where the advisor has discretion over the portfolio's overall allocation in the first place. Which means that while advisors might charge less for conservative model portfolios compared to those that are more aggressive (and in theory have more active management opportunities), or begin to unbundle their planning and investment management fees altogether, but the question of whether to charge differently for bonds and stocks within the same portfolio may soon be a moot point anyway!

Investing In Peer-To-Peer Lending As An Alternative Fixed Income Asset Class

November 18, 2015 07:01 am 38 Comments CATEGORY: Investments

While much of the growth in P2P lending (over $5B in loan volume in 2014 alone!) has been driven by borrowers looking for appealing alternatives to traditional banks and financial institutions like credit card companies, the growth has only been possible because of the matching investor demand. After all, from the investor’s perspective, P2P loan investing is little more than an opportunity to lend money to other individuals and earn an interest rate yield, not unlike any other "bond" investment. Except in a world where Treasury Bonds and intermediate Corporate bonds or CDs may yield little more than 1% to 2%, the P2P loan has a starting yield of 5.3% for “high-quality” notes and an average rate of over 13%!

Of course, the significant caveat with Peer-to-Peer investing is that some loans will default, even over their relatively limited three to five year terms, and thus the final net returns will be substantively lower than the top-line interest rate suggests. After all, P2P loans are unsecured personal loans, often to people who have credit issues in the first place (and thus why they seek out loans with interest rates of 5.3% to almost 30%!).

Nonetheless, the rise of P2P platforms makes it feasible for investors to extensively diversify across hundreds of Peer-to-Peer lending notes by investing into fractional loan shares, managed by technology that facilitates the process of routing a borrower’s loan payments out to what might be dozens or hundreds of investors who each contributed incrementally to the loan.

In fact, the growth of the P2P marketplace, along with the introduction of institutions, is beginning to create the potential for advisors and their clients to access P2P loans, as a unique form of ‘alternative’ fixed income asset class with appealing yields. On the other hand, the growth of institutional buyers may also be pushing available investor yields down, making it harder for individual investors to compete... which is even more troubling given that P2P loans have enjoyed record net returns on the back of an economic expansion, but face the prospective risk that forward returns could be far lower if/when the next recession arrives!

Should Portfolio Allocations Be Adjusted Based On The Industry You Work In?

October 21, 2015 07:01 am 20 Comments CATEGORY: Human Capital

The traditional approach to portfolio design involves diversifying the portfolio with low-correlation investments to help maximize the portfolio’s return for a given level of risk (or alternatively to minimize risk for a given level of return).

Yet from the holistic financial planning perspective, the reality is that the portfolio – or more generally, an investor’s “financial capital” – is only one asset on the household/personal balance sheet. And for accumulators who are still working, it’s not even the biggest asset, often trumped by the individual’s human capital that may be 2X, 5X, or 10X the value of his/her financial capital!

The significance of this distinction is that to truly maximize the risk/return characteristics of an individual’s total balance sheet, and all types of capital, it’s crucial to not just view the portfolio on a standalone basis, but to invest the portfolio to diversify around the often-much-larger human capital instead. Which means workers in conservative “bond-like” jobs might have even more equity-heavy portfolios, while those in more aggressive “stock-like” jobs should invest even more conservatively!

And even for those who are otherwise comfortable with their overall level of risk and equity exposure, arguably the future of designing portfolios for accumulators in particular – where human capital is really the dominant asset – is that the asset class and sector exposures of the portfolio should be adjusted around the risk/return characteristics of the worker’s job. For instance, those who work in the tech industry might really want to own less of the Technology sector in their portfolio! And ironically, the approach is especially relevant for financial advisors themselves, who are inherently so exposed to the economic and stock market cycle by virtue of their job, that they should own less in stocks themselves… or at least, far less in Financials!

What Makes Something An (Alternative) Asset Class, Anyway?

September 19, 2012 11:06 am 4 Comments CATEGORY: Investments

The most typical definition of an asset class is a group of securities that have similar risk/return characteristics, and behave similarly in the marketplace. Thus, for instance, stocks, bonds, and cash represent the three most common asset classes, as each have different risk/return characteristics and they behave very differently in response to various economic and market events.

One of the most common ways to attempt to determine whether an investment represents a unique asset class is to examine its correlation with other investments. After all, two investments that have different risk/return characteristics and behave differently in response to market events would likely show little similarity in returns over time, thereby exhibiting a low correlation. In turn, given how Modern Portfolio Theory demonstrates that investments with a low correlation to the rest of the portfolio can lower the overall volatility of the portfolio - even if the underlying investment itself is volatile on its own - advisors have increasingly sought out low correlation "alternative" asset classes and investments to manage risk through diversification.

The caveat, however, is that in an increasingly complex financial world, having a low correlation alone can actually be a remarkably poor and misleading indicator of what constitutes an (alternative) asset class.

Weekend Reading For Financial Planners (November 16-17, 2024)

November 15, 2024 02:01 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 latest Fidelity RIA Benchmarking Study shows that while RIAs saw gains in AUM and revenue last year, their operating margins tightened, suggesting that rising expenses are cutting into firm profits. The study also looked at what “high performing” firms are doing differently than their peers, finding that these firms have a higher close rate on referred prospects, were better able to maintain pricing discipline, and had significantly lower expenses as a percentage of firm revenue.

Also in industry news this week:

NASAA has proposed an amendment to its broker-dealer conduct model rule that would restrict the use of the terms “advisor” and “adviser” for broker-dealers and their registered representatives who are not also investment advisers or investment adviser representatives
A recent study suggests that large RIA consolidators are becoming more like their large broker-dealer counterparts, not only in terms of the AUM they control, but also in the types of services they offer advisors under their umbrella

From there, we have several articles on tax planning:

7 year-end tax strategies advisors can consider to help their clients lower their tax bill this year and into the future
Why seeking to minimize a client’s current-year tax bill isn’t always the optimal strategy when considering their lifetime tax obligations and their lifestyle needs
While RMDs are a fact of life for many retired clients, advisors can help make the most of them by strategically selecting assets to fund the distribution to meet asset allocation and asset location goals

We also have a number of articles on advisor marketing:

How lead segmentation can boost the effectiveness of an advisor’s email marketing campaign
A 3-email sequence to effectively welcome new leads to an advisor’s email list and encourage them to engage with the firm
A review of email marketing software providers, which can vary significantly based on features and price

We wrap up with 3 final articles, all about college planning:

How, contrary to popular belief, the sticker price of college tuition (and particularly the average net price students actually pay) has lagged the broader inflation rate in recent years
Why the increasing use of ‘merit aid’ among colleges makes high school grades important not only for college admission, but also for the breadth of schools they might consider
A tool that lets users evaluate the return on investment of different degree programs, colleges, and majors shows that getting a degree still typically comes with a significant (though not universal) positive financial return

Enjoy the ‘light’ reading!

Quantifying (More Accurately) The Real Impact Of A Financial Advisor’s Costs On Their Clients’ Nest Eggs

October 23, 2024 07:02 am 0 Comments CATEGORY: General Planning

While the financial advice industry has transformed in many ways over the past several decades, one aspect that has remained relatively constant is the use of the Assets Under Management (AUM) fee model as a common way for many advisors to get paid. Though in practice, while a 1% AUM fee is a common 'starting point' in the industry, the actual fee structure can vary based on the firm's approach; for example, some firms may reduce the fee for high-net-worth clients, or charge an additional fee for separate and additional services (from deeper financial planning to add-ons like tax preparation).

However, over the years, the 1% AUM fee has faced criticism from those who argue that it reduces the value of a portfolio by more than the advisor's guidance adds. This argument is particularly common in the financial independence and personal finance space, with financial educators like Ramit Sethi being a notable critic. AUM detractors like Sethi often present a calculation that compares the performance of 2 identical portfolios – one managed by an advisor who charges a 1% AUM fee for 20+ years, and one without an advisor – illustrating how the fee can significantly erode the cumulative value of their portfolio by the time they reach retirement.

With this line of criticism becoming increasingly common in online financial spaces, how can advisors with a 1% fee structure explain their value to curious (or critical) prospects? One key starting point is to acknowledge that technically, all spending reduces the total amount that a person could have saved and had available for retirement. And almost any 'normal' household expenditure can add up to a lot when it's compounded out, at a market rate of return, for multiple decades. For example, buying a new Honda every 10 years, instead of saving those payments, may take a greater piece of a client's retirement nest egg than a 1% advisory fee. So too does the impact of the infamous daily latte. Comparing expenses to what they could have been worth if saved in a portfolio can be misleading – because from that perspective, every expense seems unfavorable! And in practice, even flat-fee and subscription models of financial planning can still have a similar long-term impact on a consumer's financial future, when only the advisor's ongoing costs are considered.

Additionally, it's worth noting that while Sethi and other financial influencers advocate against the 1% AUM fee, much of their criticism targets those who charge a percentage of AUM but focus more on selling products than on supporting a client's long-term well-being, conflating financial salespeople with actual financial advisors. However, many consumers may not fully understand these nuances of the financial advice industry, and could mistakenly assume that all advisors charging AUM fees operate this way.

For prospects concerned about long-term AUM costs – and financial advisors exploring the benefits of a financial planning engagement with them – it may be helpful to highlight the value advisors provide beyond 'just' asset allocation. For example, firms that offer services like tax-loss harvesting, systematic rebalancing, and behavioral coaching often more than 'earn' their 1% AUM fee by saving clients money in taxes and other areas. Advisors who can explain their fee in the context of a holistic strategy – and connect it back to the pain points a client faces – can address these concerns before prospects become clients.

Ultimately, the key point is that while criticism of the 1% AUM fee may be widespread, and it's fair to recognize that financial advice does have a cost that advisors should be expected to offset by the value they provide, advisors who lead with holistic financial planning have a lot of value to demonstrate, especially when engaged on an ongoing basis, to help prospects better understand the true costs and benefits of having a trusted financial advisor in their corner!

Weekend Reading For Financial Planners (June 29-30)

June 28, 2024 02:00 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 a recent study found that at a time when the number of SEC-registered broker-dealers and their registered representatives is declining, the number of SEC-registered RIAs, their assets under management, and the number of clients they serve all grew in 2023, reflecting the attractiveness of the RIA model to both advisors and clients alike and the ability for firms across the size spectrum to profitably serve clients.

Also in industry news this week:

How the SEC could target dually registered firms for enforcement of their duties to care for and manage conflicts of interest under Regulation Best Interest and the Investment Advisers Act to send a message to the industry and to clarify its expectations for these "dual-hatted" firms and their advisors
Why a shift in IRS priorities away from specifically focusing on taxpayers with more than $10 million in income for audits could result in more clients with incomes above $400,000 being audited in the coming years

From there, we have several articles on investment planning:

5 ways advisors can 'fix' the portfolios of new clients, from unwinding unintentionally concentrated positions to maximizing asset location
While concentrated investment strategies offer the promise of higher returns, the specter of unpredictable risks and, in the case of concentrated funds, misaligned incentives between fund managers and investors, can make them risky propositions
How a "total wealth approach" for portfolio management that takes a client's human capital and other non-investment assets could mitigate the downside risks to their wealth

We also have a number of articles on client meeting note-taking:

Strategies for advisors to take more effective notes in client meetings, from adopting structured frameworks to leveraging software tools
Client meeting note-taking software has emerged as one of the first AI use cases for advisors, though its use comes with compliance and security considerations
A review of available AI-enabled client meeting note-taking software, broken down by price, accuracy, security, integrations with other AdvisorTech tools, and more

We wrap up with 3 final articles, all about productivity:

How the "weighted shortest processing time" strategy can help advisors prioritize their to-do lists and why one of the best ways to boost productivity could be to shorten the list to only include what truly needs to be done
Amidst a work culture that often prioritizes time spent at the computer, why stepping away from the desk for unstructured thinking could boost workers' creativity and productivity
Why the concept of "entrenchment" suggests that achieving a "flow state" can sometimes lead to reduced productivity and wellbeing

Enjoy the 'light' reading!