Kitces.com - Advancing Knowledge in Financial Planning

The End Of History Illusion And The Problem With Goals-Based Investing

July 20, 2016 07:01 am 23 Comments CATEGORY: General Planning

The very essence of financial planning is about helping clients to formulate the strategies to achieve their goals. In this context, the role of the financial planning is to help clients articulate their future goals, and then provide recommendations for how the client can best achieve them.

There’s just one problem: research suggests that we’re not actually very good at figuring out what our future goals will be. The fundamental challenge is that, despite recognizing how much we change over time (think back on how different you were 5, 10, or 20 years ago!), we just don’t know how to envision the ways we’ll be different in the future. In fact, researchers have dubbed the phenomenon the “End Of History Illusion” – we just don’t know how to project a future that’s any different from today (which is the end of our personal history as we know it).

From the perspective of financial planning, and the rising popularity of goals-based investing, the challenge of the End Of History Illusion is that we may be encouraging retirees to save towards a vision of retirement that they won’t actually care about when retirement comes. This doesn’t mean that retirement itself won’t be relevant, but that vision of a particular retirement home, vacations, a boat on the lake, or a certain lifestyle, may not actually be very desirable when the time comes.

Which means investors should actually be cautious about tying their saving and investing habits in a way that over-commits to a particular and specific long-term goal. Instead, if we recognize the uncertainty of future goals themselves, planning for flexibility to adapt to future goals may be more effective than investing for the goals themselves!

When Does It Make Sense To Join With A Financial Advisor Partner?

July 18, 2016 07:01 am 11 Comments CATEGORY: Practice Management

The explosive growth of technology has made it possible for individual financial advisors to be more personally productive than ever before, from software to automate key tasks to the use of (virtual) assistants to even further leverage the advisor’s time.

However, the reality is that every financial advisor eventually hits some personal productivity wall – the point at which there just aren’t any hours left in the day to serve more clients, even with the assistance of a technology and a team of support. In some cases, it’s the time to manage the team itself that becomes the biggest barrier to growing further.

At that point, the opportunity for growth shifts to the need to add a financial advisor partner, where the advisor has the potential to earn a smaller slice of a much-larger pie. And in this context, the ideal of usually not just to combine together two already-successful financial advisors, but to actually find advisors who have different and complementary skillsets, which enhances the potential for the new whole to be worth more than just the sum of the individual parts.

Unfortunately, though, for many advisors the biggest challenge in adding a financial advisor partner is simply finding one in the first place. For most, the path seems to be through financial advisor conferences and events related to their platform, where it’s most feasible to find like-minded individuals. And fortunately, the availability of third-party “financial advisor compatibility assessment” tools can help to ensure that the partners will likely be able to formulate a shared vision for the future growth of their new joint business!

Weekend Reading for Financial Planners (July 16-17)

July 15, 2016 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 an announcement that the SEC will begin to audit RIAs over the use of mutual fund share classes, seeking to verify that investment advisers are really using the lowest cost institutional shares available, and not trying to double-dip into 12(b)-1 or other back-end fees on more expensive share classes. Also in the news this week was the SEC's decision to bar Dawn Bennett and fine her a whopping $4M, for what started out as an investigation into overstated AUM on her radio show and in marketing materials, and then snowballed into a fight over the SEC's use of administrative law judges.

From there, we have a few articles related to how the Department of Labor's fiduciary rule continues to ripple, including a look at the likelihood of the rule being struck down by legislators (virtually impossible) or in the courts (still highly unlikely), how advisor recruiting amongst broker-dealers has fallen a whopping 40% in the first half of 2016 (attributed in large part to uncertainty about how DoL fiduciary compliance will play out), and the ways that broker-dealers are starting to push back on financial services product manufacturers to make their commission payouts levelized and more uniform from one company to the next. There's also an article looking at a new niche RIA custodian called MoneyBlock, which specifically targets advisors who are heavy implementors of options strategies with clients.

We also have a few marketing-related articles this week, including a discussion of how asking clients to send "referrals" is far less effective than specifically asking for introductions, the approach that one start-up financial advisor has been using to achieve a whopping 76% close rate on his prospective clients, and a Journal of Financial Planning cover story that interviewed a dozen financial advisor marketing experts for a wide range of marketing tips and strategies that advisors can implement.

We wrap up with three interesting articles: the first looks at how financial advisors may increasingly play a role in spotting financial abuse of seniors, as legislators change laws to make it easier for (or even require) financial advisors to report potential abuse situations; the second is a look at how the increasing volume of data used to manage an advisory (or any) business is leading to the rise of "business dashboards", central reporting tools that pull together the relevant business data (often from several sources) and make it easier to keep track of the health of the business; and the last is a valuable reminder that as successful advisors, it's important to give back to our communities, which is not only about being charitable but also recognizing that there's a business opportunity to "do well by doing good", too.

Enjoy the "light" reading!

How DoL Fiduciary Disrupts Trade Publications And Membership Associations

July 14, 2016 08:07 am 3 Comments CATEGORY: Planning Profession

Periscope Office Hours Cover Image July 12 2016 How DoL Fiduciary Disrupts Financial Services Industry Advertising 1

The looming implementation of the Department of Labor's fiduciary rule has raised many questions about whether products like non-traded REITs, variable and indexed annuities, and actively managed mutual funds will still be able to survive and thrive when commissions are at least curtailed. And the shift raises significant challenges for the broker-dealer platforms that distribute those products. But as it turns out, broker-dealers aren't the only ones facing significant collateral damage from the coming product fallout.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at how the contraction of commission-based products may also lead to a significant contract in financial services product advertising, which could have significant spillover effects into the industry trade publications and membership associations that are highly reliant on those advertising dollars to buy ad inventory and booth sponsorships.

Ironically, though, a contraction in financial services product advertising could actually be a boon for financial advisors, as a reduction in the advertising from financial services product manufacturers after our clients' money could leave more room for advertising from companies that actually create solutions for advisors themselves. There's more room for advisor FinTech firms and industry consultants to compete for advisors' attention when they're not being crowded out by large financial services product manufacturers.

But given that solution-providers for advisors tend to be much smaller companies, with less revenue and less advertising buying power, a contraction is still coming in industry advertising, which could have harsh consequences given the over-abundance of industry trade publications and conferences, all vying for advisors' limited attention.

In the long run, though, the reality is that financial services industry advertising may end out being larger than ever. After all, if financial services product manufacturers cannot compete by paying the best commissions, and have to compete by designing and offering the best product, there's even more pressure to market that product effectively. Which means more advertising, and more spending at conferences. But given the timeline for DoL fiduciary implementation, those dollars may not show up until 2018 and beyond. In the meantime, trade publications and membership associations may be facing a very tough 2017.

How Lapsing A Life Insurance Policy With A Loan Can Cause A Tax Bomb

July 13, 2016 07:01 am 25 Comments CATEGORY: Insurance

Life insurance serves a valuable social purpose, allowing families to protect themselves against the economic consequences of an untimely death of a breadwinner. In fact, life insurance is viewed as such a positive that Congress provides significant tax preferences for insurance policies, including tax-deferral on any growth in the cash value, and a tax-free death benefit for the beneficiaries.

Another popular tax feature of life insurance is the ability to access the policy’s cash value in the form of a tax-free loan. However, in reality the tax-free treatment of a life insurance policy loan is not actually a preference for life insurance under the tax code, but the simple recognition that ultimately a policy loan is just a personal loan between the life insurance company and the policyowner, for which the life insurance cash value is collateral. A credit card cash advance isn’t taxable, nor is a cash-out mortgage refinance, and a personal loan from a life insurance company isn’t, either.

However, while a life insurance loan isn’t taxable – nor is its subsequent repayment – the presence of a life insurance loan can distort the outcome if/when a life insurance policy is surrendered or otherwise lapses. Because the insurance company will require that the loan be repaid from the proceeds of the policy.

In the case of a life insurance death benefit, this isn’t necessarily problematic. The death benefit is already tax-free, and the loan is simply repaid from the tax-free death benefit, with the remainder paid to heirs.

When a life insurance policy is surrendered or otherwise lapses, though, the remaining cash value is again used to repay the loan… even though the taxable gain is calculated ignoring the presence of the loan. Which means in the extreme, it’s possible that a life insurance policy can lapse without any remaining net cash value, due to a loan repayment, yet still produce a significant income tax liability based on the policy’s gains. This “tax bomb” occurs because in the end, even if all of a policy’s cash value is used to repay a life insurance loan, it doesn’t change the fact that if the policy had a taxable gain, the taxes are still due on the gain itself!

Assessing Compatibility To Partner With Another Financial Advisor

July 11, 2016 07:01 am 1 Comment CATEGORY: Practice Management

Even the most successful individual financial advisors can eventually hit a wall, where it’s simply not possible to make themselves more productive by growing a team to support them. The biggest advisory businesses bring together multiple successful advisors, who can each contribute their own unique (and hopefully, complementary) skillset to make the business bigger than what any one of them could achieve alone.

The caveat, however, is that just because two advisors are individually successful doesn’t mean that they will be a successful partnership. At best, different skillsets result in partners taking on more specialized roles in the business, and needing to learn to communicate well with people who have a very different perspective. At worst, the partners have fundamentally different long-term goals that eventually create untenable conflicts that cause the partnership to fail.

In an effort to avoid failed partnerships before they begin, former advisors Tanya Rapacz and Lisette Smith formed Partnership Resource, a niche consulting business that specifically works with financial advisors forming and sustaining partnerships. And their latest offering is a “Partnership Compatibility Assessment” tool, built to help advisors figure out up front whether they have sufficient alignment in what motivates them personally to be able to build a successful business together.

Of course, in the long run, there’s more to a successful partnership than “just” an alignment of business objectives and an ability to communicate and work through conflict. But given the number of financial advisor partnerships that I’ve witnessed come together and fall apart over the years, I suspect that better assessment tools like this will go a long way towards heading off the most problematic partnerships before they even begin, to the betterment of all involved!