Kitces.com - Advancing Knowledge in Financial Planning

The Myth Of “Free” No-Expense Fixed Or Equity Indexed Annuities – Interest Rate Spread Is Still A Cost!

March 18, 2015 07:01 am 28 Comments CATEGORY: Annuities

When investors hold investment accounts subject to an ongoing AUM fee, they can clearly see the expense being subtracted from the account on each statement. Similarly, variable annuities have an explicitly disclosed expense ratio that is subtracted from the account balance on an ongoing basis. However, in the case of fixed or equity-indexed annuities, investors only see their contributions into the account, and a return on the account, leading many to believe (and many insurance agents to claim) that such annuities are “free” or have no cost (and that any commissions paid to the agent are “paid by the insurance company, not the client”) and will not adversely impact their long-term retirement accumulations.

Yet the reality is that fixed annuities do still have an ongoing cost that reduces long-term returns; it’s just that instead of paying the expenses and compensation to the advisor directly out of the end value of the account each year, the costs are subtracted from the annuity company’s gross returns in the form of an interest rate spread before paying the net remaining return to the investor. Or in the case of the indexed annuity, the interest rate spread is subtracted before the remaining yield is invested into options to provide the investor’s participation rate in the index being tracked.

In fact, the whole purpose of surrender charges on annuities is simply to ensure that when an insurance agent is paid a commission upfront, the annuity funds will remain invested long enough with the ongoing interest rate spread extracted from the investor return to allow the insurance company to recover that commission cost from the investor (or else he/she pays a surrender charge to make up the difference!). In the end, this means that not only do fixed and indexed annuities have a cost to the client for compensation paid to the insurance agent that impacts long-term retirement wealth… but it’s actually remarkably similar to what investors typically pay brokers and investment advisers as well!

Meeting The Requirements To Start Your Own RIA Without Breaking The Bank

March 17, 2015 07:01 am 44 Comments CATEGORY: Practice Management

Launching a business is hard enough in any industry, but getting through the requirements for setting up an RIA and figuring out the necessary technology vendors and software to have in place when starting a firm can be especially daunting. For many potential new advisors we talk to in XY Planning Network, the hardest part (and biggest fear!) of starting a new advisory firm isn't even about getting the first few clients, it's just about the stress of figuring out what to do to actually start a firm and not miss any of the key compliance or other requirements!

In this guest post, financial planner Andrew McFadden shares his own story of what he went through in starting his RIA, from making decisions about office space and who his niche target clientele would be, to handling the compliance requirements for forming the RIA and associated business entity and obtaining E&O insurance, to all of the hardware and software choices that a startup advisor must navigate. All in, McFadden estimates that the startup process cost him only about $7,000 up front, and his practice has on ongoing overhead expense of just $500/month.

And notably, McFadden chose to launch his firm after reading a prior Nerd's Eye View guest post by Sophia Bera about how she set up her RIA and started her practice for less than $10,000 - realizing how feasible it was to get started on a modest budget, he decided to go for it, and is now "paying it forward" with his own story to inspire others.

So if you've been thinking about making your own transition from a broker-dealer to launch an independent RIA, or are wondering what it takes to launch a new financial planning practice from scratch, I hope that you find today's guest post to be helpful and inspirational as you think about how to satisfy the requirements to get started yourself!

6 Key Value Propositions A Good Financial Planner Can Provide For Clients Seeking A Better “Return On Life”

March 16, 2015 07:01 am 45 Comments CATEGORY: General Planning

As the pressures of commoditization on investment advice continue to increase, more and more advisors adopting financial planning and wealth management services for their clients. Yet compared to the world of investing – where an advisor’s value proposition can be clearly articulated and measured in dollars and cents – it’s far more difficult to convey the value proposition of an intangible long-term service like financial planning. Determining whether an advisor provided a good Return On Investment in the portfolio is one thing, but how do you describe the ways an advisor tries to help a client get a better “Return On Life”?

In what may be one of the best clear descriptions of the key value propositions that financial planners provide, financial life planning pioneer Mitch Anthony boils it down to 6 key phrases: we provide Organization, Accountability, Objectivity, Proactivity, Education, and Partnership. While the words themselves aren’t necessarily new and unique, Anthony’s way of weaving them together into a Return-On-Life value proposition for clients certainly is.

Of course, the caveat is that just saying you can deliver on these value propositions to clients is one thing; actually doing so is another. Yet accordingly, this means that Mitch Anthony’s framework for a financial planner’s value arguably provides not only a good description for clients, but also a guidepost for advisors about where they should focus their own energies. Do you think these 6 key value propositions are a good way to describe the benefits of financial planning to clients? And can you really deliver them?

Weekend Reading for Financial Planners (Mar 14-15)

March 13, 2015 02:01 pm 17 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a review of the latest SEC and FINRA guidance on top areas of concern regarding their oversight of advisors, from cybersecurity to how advisors oversee multi-advisor firms to increased scrutiny on retirement rollovers and advisors with multiple fee schedules (and how clients end out in one versus another).

From there, we have a long list of practice management articles this week, including: a discussion of valuing practices based on a multiple of (discounted) cash flow rather than just a multiple of revenues; whether the recent shift of United Capital from acquisitions to tuck-ins signifies a potential slowdown in advisor mergers and acquisitions; how "acquisition" succession planning is typically structured and implemented in wirehouses; what wirehouse advisors should consider (especially about mundane but important arrangements like office space) if they're planning to break away and go independent; a reminder that clients care less about what you do than why you do it; how clarity about where a business is heading in the long run can help to get staff to stay focused on what they should be working on; the long-term growth problems that emerge for advisors who create an "anti-selling" culture; and a discussion of why, even though it can sting, getting "fired" by a client can be a good thing if the reality was that you weren't really a fit for their needs anymore anyway.

We wrap up with three interesting articles: the first is a discussion by financial life planner Mitch Anthony about how we can help clients "add life to their years" by helping them to consider encore careers rather than just an all-or-none retirement transition; the second is an interview with advisor-to-advisors legend Nick Murray as he shares his wisdom about how to be successful as an advisor; and the last is a discussion of the recent launch of the Schwab Intelligent Portfolios solution and whether Schwab has lost the focus on its core values given the swirling discussions of the conflicts of interest around its "free" solution and its potentially significant (and more-profitable-to-Schwab) cash allocations.

And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including a discussion of the Charles Schwab and Wealthfront fight, Fidelity's Apple Watch app, and a discussion of how advisors can use screencasting tools like Camtasia!

Why A Mortgage Is Not Actually An Inflation Hedge Itself, But Can Provide Access To Investments That Are

March 11, 2015 07:01 am 25 Comments CATEGORY: Debt & Liabilities

Having a mortgage is often framed as a way for an inflation hedge. As the conventional wisdom goes, with a mortgage your monthly payment is locked in (assuming it’s not an Adjustable-Rate Mortgage [ARM]), even if inflation goes up and interest rates rise. In fact, rising inflation would just devalue the mortgage in nominal (future) dollars.

Yet the reality is that ultimately, a mortgage may be paid off with inflation-adjusted wages, free up funds to be invested into inflation-hedging vehicles (from TIPS to equities), used to create a reserve for investing in bonds at higher rates in the future (a form of call option on interest rates), or be deployed to purchase a residence that provides a hedge against rising rents. In all of these scenarios, though, it is actually how the mortgage-related funds are deployed, or the income sources used to fund it, that are the actual inflation hedges… not the mortgage itself!

Ultimately, this doesn’t mean that a mortgage can’t indirect lead to beneficial outcomes if inflation (and interest rates) rise. But in the end, the benefits will not actually come from the use of the mortgage itself as an inflation hedge, but the other inflation-adjusted assets and income an individual has to support the mortgage instead! Of course, the caveat is that the use of leverage to hedge inflation can cut both ways, and magnify the unfavorable outcomes in non-inflation scenarios as well!

What Robo-Advisors Truly Threaten To Disrupt: Index ETFs and Mutual Funds, Smart Beta And Algorithmic Investing, Custodians and Their Advisor FinTech Ecosystem

March 9, 2015 07:01 am 30 Comments CATEGORY: Technology & Advisor FinTech

While the debate rages on about whether robo-advisors will ultimately be a threat to human advisors, or whether the solutions that combined technology and humans will be the ultimate victors, the reality is that to view the battle as one of “technology vs human advisors” may be missing the real “threat” of robo-advisors. As technology platforms, their disruptive potential goes far beyond just impacting financial advisors.

For instance, the ability of software tools to re-create index funds – but without the mutual fund or ETF wrapper – creates the potential for today’s robo-advisors to disintermediate much of the existing index fund industry, aided by the tailwind of a benefit under tax code that uniquely favors these new “Indexing 2.0” robo-platforms over current fund-based solutions. Similarly, robo-advisors as “trading” software creates the potential to eliminate many active management middlemen, allowing a wide range of smart beta and rules-based trading algorithms to be implemented and automated directly.

And as the robo-technology trends shift from a direct-to-consumer focus to offer new robo-advisors-for-advisors solutions instead, the new platforms present the threat to today’s existing RIA custodians, who face the potential of a generational shift as new less-investment-centric financial planners adopt simplified robo-advisor investment platforms, and build a business there for the long run… which means in the end, the greatest threat of robo-advisors may not be their competition with human advisors, but the way that human advisors adopt them to disrupt much of the existing FinTech ecosystem!