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Deducting Financial Planning And Retainer Fees, And The (Tax) Problem With Bundled AUM Fees

May 20, 2015 07:01 am 24 Comments CATEGORY: Taxes

Under the Internal Revenue Code, expenses for investment management are tax deductible. Accordingly, taxpayers are permitted to deduct the typical assets-under-management (AUM) fee of an investment manager. However, financial planning fees not specifically attributable to investment management (or tax planning) are non-deductible, treated instead as a personal expense.

With the rise of wealth management, though, it is increasingly common for consumers to pay a single “bundled” AUM fee, that covers not only (deductible) investment management services, but also (non-deductible) financial planning as well. Which means technically, those clients should probably only be deducting a portion of the AUM fee, not the entire amount – at least, where the AUM fee covers a “material” amount of financial planning services. And the issue is especially concerning when it comes to retirement accounts like IRAs, where paying a personal financial planning fee with retirement assets could trigger a (taxable) deemed distribution, or at worst disqualify the entire IRA as a prohibited transaction!

Ultimately, the easiest solution to the problem – at least from a tax perspective – is simply to unbundle the financial planning and investment management fees. And in fact, unbundling is now required under new IRS regulations when it comes to the investment management vs administration and other fees for estates and trusts. Yet for some firms, unbundling fees can present other business challenges about communicating the value of their services.

Fortunately, the issue may not receive scrutiny anytime soon, given that many advisory firms with bundled fees are still charging the same as investment-only firms (implying the financial planning fees may not be "material" from a tax perspective). Nonetheless, as long as the tax treatment is different for financial planning versus investment management fees, advisors should at least be cautious about how those various financial advisor fees are characterized by clients, especially when extracted directly from an IRA!

The Fundamental Challenge For Advisor Matching Services – Algorithms Can’t Differentiate Advisors Who Can’t Differentiate Themselves

May 18, 2015 07:01 am 20 Comments CATEGORY: Technology & Advisor FinTech

With the ongoing rise of advisor FinTech, one of the “hot” new categories starting to emerge are “Advisor Matching” services – websites where consumers can enter some personal information, and get suggested “matches” of potential advisors who can help them with their financial issues. Ideally, consumers get a potential advisor who can solve their problems, and advisors save time by being matched to prospective clients who are a good fit for their services.

However, thus far the ideal rarely matches the reality. The fundamental problem with building a “Match.com for Advisors” service is that it’s almost impossible to effectively screen and filter a list of potential advisors when most advisors are generalists who work with a far-too-wide swatch of consumers in the first place. If advisors don’t differentiate themselves, an advisor matching service can’t differentiate amongst them, either! And ironically, the advisors who do differentiate themselves with a niche or specialization will likely have better sources of clients than a generalist advisor matching service anyway!

Compounding the challenge of creating a viable advisor matching service is the simple reality that it’s expensive to market and build the trusted brand – whether as an advisor, or a “trusted” website to find one – necessary to generate a sufficient volume of highly qualified prospective clients. Which means in the end, even though advisors will pay astonishingly well for new clients – which means a “Match.com for Advisors” solution will be highly lucrative, if the puzzle can be solved – the low trust in financial services and incredibly high costs of client acquisition may be just as destructive for advisor matching services as they are for the advisors being helped.

Weekend Reading for Financial Planners (May 16-17)

May 15, 2015 02:01 pm 16 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the news that major ETF providers have been establishing and expanding their lines of credit to prepare for a possible liquidity squeeze that could emerge in a market crisis, where a sell-off could force ETF redemptions that would be difficult to fund if/when the underlying securities are illiquid (e.g., with many types of bond and other fixed-income ETFs, as well as emerging markets). The news accentuates the warnings from some pundits, who have cautioned against the risks of owning "liquid" ETFs that are wrapped around otherwise illiquid securities.

From there, we have a few practice management articles this week, particularly focused around succession and continuity planning for advisory firms, including: a look at the key provisions to watch for in establishing a continuity agreement with another advisory firm that would take over in the event of death or disability; a discussion of the key succession planning issues firms should consider if the SEC adopts a succession/continuity planning requirement similar to the recent NASAA Model Rule on Succession Planning for state-registered investment advisers; how advisory firm owners can regain that "new business" feeling if they've otherwise lost their energy and focus in the practice; and whether there may be a quiet "demographics tsunami" still lurking as the average age of advisory firm owners approaches age 62 and more and more consider potential retirement.

We also have a couple more technical articles this week, from a look at some research suggesting that baby boomers may not actually be so far behind in retirement after all (once you consider their ability to spend less and save more as kids finally leave the home), to a discussion of the benefits of variable retirement spending strategies that "smooth" the spending in volatile years. There's also an article on how Medicare Part B and Part D premiums will be increased in 2018 for certain higher income individuals, and a discussion of a new type of long-term care insurance policy from John Hancock that will use "flex credits" to create a kind of LTC coverage that is "participating" similar to dividend-paying whole life insurance.

We wrap up with three interesting articles: the first examines the history of 401(k) plans and how they have evolved from a supplemental retirement plan to one of the key foundational pillars of retirement, which raises the question of whether the current structure of 401(k) plans is still "right" as such a widespread solution; the second article looks at how the SEC has become increasingly gridlocked over the past decade as the five SEC commissioners have become increasingly partisan; and the last is a story about "10 Young Advisors To Watch", highlighting the inspiring stories of 10 up-and-coming advisors who show how much talent there is in today's emerging next generation financial planner.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including a recent Investor Alert from the SEC about the risks of "Automated Investment Tools" (i.e., robo-advisors), the latest efforts of Envestnet to build its "Advisor Now" platform, and a review of the buzz from this week's Finovate Spring 2015 conference!

Enjoy the reading!

The Incredible Shrinking Alpha – What Was Once Alpha Is Now (Five-)Factor Beta?

May 13, 2015 07:01 am 21 Comments CATEGORY: Investments

In the world of investing, the Holy Grail is finding an investment manager who can reliably, persistently deliver alpha – a feat that seems to be of increasing rarity, as active managers in the aggregate continue to see outflows due to ongoing underperformance.

Yet in their new book “The Incredible Shrinking Alpha”, Larry Swedroe and Andrew Berkin make the case that the woes of the active management industry are not merely an artifact of the post-financial-crisis investment environment, but are a result of the ongoing evolution of the investment management industry.

As research continues to identify unique risk factors that are rewarded with excess returns, what was once believed to be alpha is increasingly turning out to be an active manager who simply invested to benefit from a not-yet-identified-as-such risk factor. Yet as the number of known risk factors increases – along with the availability of new solutions to passively invest in them at a low cost – it is more and more difficult to find active managers really adding something beyond an appropriately-factor-adjusted benchmark. And the situation is only further complicated by an increasing volume of professional managers competing against each other for a limited pool of available alpha where it is harder than ever to outperform against similarly-highly-skilled peers.

Of course, the caveat is that just as the investment research has evolved from one factor to three and now five, more factors may be found in the future that still create alpha opportunities in today’s marketplace. And given that not all factors are favored at once, tactically allocating amongst the risk factors may also present an opportunity for an active manager to add value. Nonetheless, Swedroe and Berkin do make a compelling case that the odds an active manager can even find any alpha, and wrest it from increasingly competitive set of peers, is not great, as getting a hold of a reasonable share of the shrinking pool of alpha is truly harder than it has ever been.

A Primer On GIPS Compliance And Verification For Financial Advisors

May 12, 2015 07:01 am 7 Comments CATEGORY: Investments

In the world of investment advisors, competition has long been driven at least in part by investment performance results. Yet the challenge is that performance reporting can also be prone to abuse, due to the lack of consistent standards - amongst individual financial advisors in particular - about how those results are measured and reported in the first place. In fact, in recent years a number of advisory firms are trying to improve their performance reporting process to meet the Global Investment Performance Standards (GIPS) requirements specifically as a means to differentiate themselves.

Accordingly, in this guest post, GIPS compliance consultant Amy Jones and marketing expert Thusith Mahanama share some of the details that advisors should be aware of in considering whether to pursue the path of GIPS-compliant performance reporting for their own advisory firm. And notably - as the authors point out - the decision about whether to pursue GIPS-compliant reporting is a firm-wide decision, as one of the first key requirements of GIPS reporting is that it must be done on a firm-wide basis, to eliminate the potential that advisors try to cherry-pick the best performing accounts to include in their composite results.

So if you're an advisory firm that manages portfolios on a model basis, and have already been considering whether to adopt GIPS as a means to differentiate yourself, hopefully this primer on the requirements for GIPS compliance will be helpful for you. Alternatively, if you're an advisory firm that's had strong results for clients but is currently struggling to differentiate yourself from the marketing of other advisory firms, you may find the idea of GIPS-compliant reporting appealing as a means to differentiate why your performance reporting results really should be viewed as more 'credible' than the competition!

The Problem With Having Client Passwords – Beware The SEC Custody Rule For Advisors

May 11, 2015 07:01 am 15 Comments CATEGORY: Practice Management

The so-called RIA “Custody Rule” under the Investment Advisers Act of 1940 was designed to ensure additional oversight of an RIA that has actual possession of client assets, including both additional reporting to clients, and the requirement of a “surprise” annual audit of the firm. Given the costs involved to comply, most RIAs will go out of their way to avoid having custody so that the rules aren’t triggered.

Yet a recent SEC “Risk Alert”, rule warns that as many as 1/3^rd of RIAs are failing to comply properly with the custody rule, most commonly because the RIA fails to realize it has custody in the first place! As the SEC notes, just using a third-party custodian like Schwab or Fidelity alone is not a safe harbor; there are many ways an RIA can indirectly trigger custody, from being a trustee on a client’s account, to providing bill-pay services, and even “just” having a client’s username and password for their 401(k) can be enough to trigger the rule sometimes!

Accordingly, as RIAs continue to expand their services to differentiate in today’s increasingly competitive environment, it is more crucial than ever for firms to be aware of where the line is when it comes to the custody rule. In some cases, firms may decide that having custody – and handling the additional compliance requirements – is worthwhile for the service that will be provided to clients. But if the goal is to not have custody, firms need to be more cautious than ever about how their services are executed – and some may need to step back from a line they’ve already crossed, when it comes to common situations like having client login details to rebalance their accounts!