Kitces.com - Advancing Knowledge in Financial Planning

Re-Evaluating The CFP Board’s “3 Buckets” Approach For Determining Fee-Only Compensation

November 25, 2013 07:01 am 9 Comments CATEGORY: Planning Profession

In recent months, the CFP Board has been buffeted by criticism of its current compensation disclosure rules - built upon a series of definitions that the CFP Board insists have not been changed since the Practice Standards were approved after a public comment process more than 5 years ago, yet appear to be impacting so many advisors that it's difficult to understand how the current way the CFP Board is interpreting its rules is anything but a change from how things once were.

The key point of dispute appears to revolve around the CFP Board's use of its so-called "3 buckets" approach to determining the types of compensation an advisor receives, which looks at what clients pay to the advisor, to related parties, and how the advisor themselves generate income from their employment and ownership interests. In the process, the definition of what constitutes "compensation" has stretched so far that advisors can now be disciplined for failing to disclose types of compensation that don't actually exist because no client has ever actually paid it to anyone, ever!

Accordingly, it's time for the CFP Board to "clarify" its 3 buckets approach to recognize that the fundamental starting point for all types of compensation disclosure should always be what clients actually pay in the first place. The fact that no client has ever actually paid a commission to anyone, ever, should always be a valid defense for an advisor to claim that they are fee-only (and the same should apply to commission-only advisors whose clients have never paid fees, and who are equally in "violation" of the CFP Board's current rules). By fixing its confused and problematic rule, the CFP Board can start to move past its recent compensation disclosure debacles and move the definitions in line with a clear and logical rule that consumers can actually understand, and eliminate the absurd requirement for advisors to disclose (and potentially be punished for failing to disclose) client compensation that doesn't actually exist!

Weekend Reading for Financial Planners (Nov 23-24) – Practice Management Edition!

November 22, 2013 03:01 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" practice management edition! This week's reading kicks off with an interesting interview with "robo-advisor" Betterment CEO Jon Stein, who seems to be shifting in acknowledging that perhaps his platform will be more likely to co-exist with advisors than compete directly with them (though that doesn't slow Stein from a lofty goal for a whopping $100B of AUM in 5-7 years!).

From there, we have a long array of practice management articles this week, including: an overview of the results of the 2013 FA Insight People and Pay industry benchmarking study; a discussion by practice management consultant Angie Herbers of the most common fatal succession planning mistake (focusing too much on valuation) and how to manage it; an interesting survey of new advisors that highlights what a subset of "quick starters" are doing to succeed (growing their businesses to more than $50M of AUM in under 5 years); how female advisors, while still forming a small minority of total advisors, are actually winning on some key advisor metrics for success; how "big data" solutions are coming soon to help advisors better manage their practices and serve their clients, with an initial glimpse at two new offerings; and a review of the latest Redtail Document Imaging software solution for advisors.

There are also some articles specifically about marketing and business development, including: an overview of 3 services that help advisors to better market and grow; how some advisors are having extraordinary new business success by attracting clients through Yelp, albeit while operating in a "grey" area of compliance; and some guidance from Bill Winterberg on how advisors can get started with video on their websites.

We wrap up with three interesting articles: the first is a good discussion from Mark Tibergien about what it really means when firm owners say they want staff and especially future partners to "act more like an owner"; the second is a look at the latest trends in website development for financial advisors and some examples of the advisory world's best advisor websites; and the last is a discussion of how advisors need to look beyond classic business metrics to really measure "success" or risk evolving their businesses in ways they didn't intend. Enjoy the reading!

Can Variable Annuities Really Offer Insurance Guarantees Against A Market Catastrophe?

November 20, 2013 06:42 am 34 Comments CATEGORY: Annuities

Since the tech crash, it has been increasingly popular to purchase variable annuities with "guaranteed living benefit" riders to help protect retirement income against the risk of a market catastrophe. The basic premise of the contracts is rather straightforward: for a modest cost, the insured can transfer the risk of a severe market decline to the insurance company, and remain assured that guaranteed retirement income will be available for life, undiminished by the market decline. In the meantime, the annuity owner has the opportunity to stay invested in the market, with the hopes of generating an ever greater upside (albeit reduced by the costs of the annuity).

The problem, however, is that unlike most types of insurance - where the law of large numbers allows the insurance company to have relative certainty about the timing and magnitude of potential claims - in the case of annuities with income guarantees against a market decline, the insurance company faces virtually no risk exposure for any of its policyowners, until a major market decline actually occurs... and then, suddenly, the insurance company must set aside reserves for everyone, all at once. The end result is that market volatility can end out creating drastic volatility in the required reserves and profitability of the insurance company - to such an extent that in the past several years, many major insurers have decided to stop offering the guarantees altogether.

In the aggregate, the problem is that having a large group of prospective policyowners transfer their exposure to market risk to the insurance company may seem like the risk is being transferred from the policyowner's perspective, but the risk is actually being concentrated from the insurance company's perspective, in a remarkably undiversified manner. As a result, the policyowners actually face the danger of turning what was a systemic risk exposure to overall markets into a very specific, undiversified, unsystematic risk exposure to the credit quality of a particular (insurance) company instead. And for those who fear the danger of a "black swan" event, the reality suddenly becomes clear that the kinds of black swans that could be a blow to markets may actually be an even more severe blow to the insurance companies trying to guarantee against them, as was evidenced by the need of at least one annuity provider to access Federal TARP funds for liquidity in the immediate aftermath of the financial crisis.

Ironically, it turns out the best alternative may simply be the solution that advisors recommended before such annuity contracts were available in the first place: to invest more conservatively, and spend more conservatively, and simply stay the course and weather the storm. After all, conservative spenders following a safe withdrawal rate approach have largely recovered their declines since the financial crisis, while many insurance companies have left for good; similarly, while the safe withdrawal rate weathered the Great Depression, many insurance companies did not. Of course, in today's marketplace, the annuity companies have finally figured out how to proper structure, constrain, and price annuity guarantees to manage their risk exposures and make the products economically feasible to be offered; yet the outcome of such pricing may be leading to the point where their floor-with-upside guarantees are no longer an appealing trade-off for the (new) cost.

When Will There Finally Be A Good Personal Financial Manager (PFM) Software Solution For Advisors?

November 18, 2013 06:01 am 38 Comments CATEGORY: Technology & Advisor FinTech

In the world of technology, some of the most cutting edge computers, tools, and software are bought and used by Wall Street. Yet the reach of technology to financial advisors has been severely limited; at best, most solution categories have only a handful of players, often built around homegrown tools creative by/for one advisor and marketed to others, or much larger platforms that have to be extensively adapted and customized to actually be relevant for financial advisors. To the extent that any venture capital dollars are invested into financial services solutions, it seems they tend to be offered directly to consumers, rather than as a tool for advisors.

One of the key areas where this shortcoming is most notable is the world of “Personal Financial Management” (PFM) software, where market dominator Mint.com serves consumers directly, but has not been adapted or expanded for use with advisors, and the alternatives actually available for advisors are meager at best, often focusing solely on aggregating investment and retirement assets but falling far short of a comprehensive financial planning solution.

Nonetheless, the market potential for a PFM serving advisors is huge; while most direct-to-consumer solutions struggle to generate enough revenue to be financially successful while trying to get consumers to pay directly, or to induce consumers to buy other financial services products the tool recommends, advisors might happily pay an ongoing fee for an effective solution targeted directly for them. After all, imagine if you as an advisor could have your clients enter simple financial account information into a computer and have an immediate snapshot of the client’s assets, liabilities, and cash flows in the very first meeting (and every plan renewal thereafter). The tremendous efficiency and productivity enhancement – not to mention a better client experience – could be a breakthrough for expanding the reach of financial planning!

Which raises the question – when will a financial technology startup finally take up the incredibly low-hanging business fruit, rise to the challenge, and build the advisor PFM tool we could all so desperately use?! And why isn't the allure of a company that could generate tens of millions of steadily recurring revenue from advisors enough to draw venture capital interest!?

Weekend Reading for Financial Planners (Nov 16-17)

November 15, 2013 01:01 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with some big news from the CFP Board, which announced this week that it will not be pursuing its controversial proposal to offer CFP CE credit, and instead will be offering up a series of initiatives over the next 3-5 years aimed at lifting the overall quality of CFP CE across all programs; in addition, the CFP Board also announced that it will be extending its "Let's Make A Plan" public awareness campaign by another two years, citing better-than-expected results from its public awareness metrics.

From there, we have several regulatory-related articles this week (following on the heels of Tuesday's guest blog post regarding FINRA's significant fiduciary shift with its recent "Report on Conflicts of Interest"), including a new consumer educational program from Wall Street trade organization SIFMA entitled "Our Partnership With You" that advocates consumers should receive best-interests personal investment advice (though the word "fiduciary" was not used), an announcement by FINRA that it is making its BrokerCheck and IARD systems more accessible and consumer-friendly for those who want to check up on their advisors, and a summary of the current state of various fiduciary activity (from the SEC, DOL, and FINRA) presented at this week's Schwab IMPACT conference (along with another article that provides overall highlights from the event).

There are also a few technical articles, including a good summary of this week's proposals to "fix" the Obamacare problems by extending the time period that insurance companies can renew "old" insurance plans without cancelling them (and some of the problems with trying to do so), the potential coming offering of new "R-Bonds" from the US Treasury as a new kind of IRA alternative, a discussion of some of the practical caveats and limitations to the 4% "rule", and an interesting look at just how long it may take for a total return bond fund to recover from various interest rate increases (hint: a while, but not as long as clients might fear, and still with far less volatility than equities).

We wrap up with three interesting articles: the first looks at how bland and sometimes unprofessional the typical "Out of Office" email is, or at best how it's purely "AUTOREPLY" style is at odds with what are otherwise high-touch high-relationship advisory firms (and some suggestions about how to improve accordingly); the second is from Steve Lockshin about trends that are likely to impact the advisory world in the coming years (excerpted from his recently published book "Get Wise To Your Advisor"); and the last provides a good reminder about how important it is to have a clear mission for your firm, noting not only do customers/clients increasingly prefer mission-driven companies, but that employees who worked at firms with clear mission and follow-through were twice as likely to want to stay with their current employer and three times more likely to have high job satisfaction! Enjoy the reading!

The Idiocy Of The IPO Price Pop

November 13, 2013 06:07 am 9 Comments CATEGORY: Investments

With the rise of social media companies in recent years, there's been a rise of social media company IPOs, creating a frenzy almost on par with some tech company IPOs of the late 1990s, especially for big, high-profile companies like Facebook and more recently, Twitter.

Yet along the way, it seems that we've lost perspective of what constitutes a "successful" IPO in the first place; while Twitter has been hailed as a success, with its whopping 73% pop in its IPO, while Facebook was viewed rather negatively, as the company struggled to even hold its IPO price in the open markets, the reality is that from the perspective of the companies themselves, arguably Facebook was the success and Twitter marks Wall Street at its worst. After all, think about it from the perspective of the company - if you were selling a portion of your business to raise capital, you want to see your portion of the sale occur at the best price possible, not at an lower price that limits the benefit for the company and maximizes the short-term profit for those lucky enough to get their hands on an "underpriced" IPO!

While the reality is that some price "pop" on the day of an IPO is healthy, inasmuch as it alleviates fears of IPO buyers and makes them more comfortable to take on the risky unknown that is IPO pre-commitment of share purchases. Nonetheless, the fact remains that expecting a pop as big as the one Twitter saw may be more notable for the amount of money Twitter left on the table - money that the company won't be able to use towards justifying the market capitalization that has now been established. And from the individual investor's perspective, arguably buying IPO shares on the open market when they start trading - the practical reality for most retail investors who don't have access to direct IPO shares - represents the worst of both worlds, simultaneously paying the maximum price for the shares, and investing in a company that doesn't even get the full benefit of its own IPO value. So perhaps its time to stop celebrating the idiocy of the big IPO price pop, something that benefits neither the retail investor, nor the company they're buying!