Weekend Reading for Financial Planners (June 16-17)

Posted by Michael Kitces on Friday, June 15th, 6:00 pm, 2012 in Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts off with a rather scathing article by NAPFA Chairman Ron Rhoades on why FINRA not only shouldn't be the SRO for investment advisors, but is failing its original charter and should be disbanded altogether. From there, we look at two technical estate planning articles - one on the different ways that incapacity is defined for trigger powers of attorney or even the competence to sign a Will or trust in the first place, and the other on how beneficiaries can potentially try to "bust" trusts that are no longer working as desired. We look at three practice management articles this week, including Mark Tibergien's latest offering on the importance of managing expenses as well as revenue growth, reporting on the recent FA Insight study showing firms with more widely distributed ownership are consistently better performers, and results from an Investment Advisor / ActiFi study at what practice management issues are most important to advisors and where they're currently getting help (surprising result - broker/dealers may be stepping up far more than custodians). We also look at an interesting retirement income analysis from Joe Tomlinson suggesting that SPIAs might be particularly effective for retirement portfolios despite - and in fact, because - of low current rates, and an analysis by Geoff Considine about why advisors may be giving short shrift to Master Limited Partnerships in their portfolios. We finish with a sharp analysis by John Hussman about what's really at the heart of the ongoing global economic malaise, an interesting write-up by Bob Veres about several presentations about trust at the recent FPA Retreat conference, and a lighter article by Abby Salameh on RIABiz abuot how to take a breath and relax to avoid being overwhelmed as a busy advisor. Enjoy the reading!

Weekend reading for June 16th/17th:

An In-Depth Analysis Of FINRA's Attempted Takeover Of RIAs And Why The Group Should Be Disbanded - This article on RIABiz by new NAPFA Chairman Ron Rhoades, details the failings of FINRA in the recent decade, leading up to the financial crisis. Rhoades lays the blame at FINRA's conflicts of influence - specifically, the undue influence exerted on the organization when its board and leadership is heavily comprised of the very members it is intended to oversee and regulate. Rhoades also notes that the origin of the NASD (now FINRA) in 1938 was to raise the standards of the industry under the Maloney Act... yet in reality, the NASD has a litany of failures, from FINRA's role (or lack thereof) in the Madoff scandal, to its failure to investigate tips about the $7 billion Stanford fraud, to poor oversight of derivatives, to the conflicts between stock analysis and underwriters a decade ago, to FINRA's allowance of public confusion by not properly overseeing the use of titles and descriptors by registered representatives, and more. Rhoades suggests that FINRA not only needs to be fixed, but should potentially be dismantled altogether as a failed institution, and replaced with a more effective regulatory structure. Moreover, Rhoades notes the potentially dire consequences for independent RIAs if FINRA becomes the regulator of investment advisors, noting the lack of RIA representation in FINRA leadership (which means it's not really "self" regulation anymore but regulating the competition from the the broker/dealer perspective), and FINRA's ongoing failures to effectively protect the public from poor investment products. Although the article reads a bit long, it is one of the more thorough evaluations and indictments of FINRA's effectiveness that you'll see.

Defining Incapacity in the Modern Estate Plan - This article from the Journal of Financial Planning takes a look at some of the legal definitions of "capacity" - as in, does the client have mental capacity to complete estate planning document, or is he/she incapacitated. Notably, the article points out that in many states, the laws defining mental capacity to enter into a Will are different than the laws that define capacity to enter into a legal contract, including a revocable living trust. The latter has the higher standard; as a result, it's actually possible that a client could have capacity to change a Will but not update/implement a revocable trust! The article provides a number of factors that can be assessed to evaluate (mental) incapacity, and looks at the pros and cons of different ways that incapacity can be decided (by a loved one, physician, multiple physicians, courts, etc.). Overall, the article is a nice review of issues to consider and be aware of when discussing incapacity planning - and estate planning more generally - with clients.

Busting Trusts - This article from financial planning magazine looks at how advisors and their clients can "bust" trusts, modifying or changing them in situations where an old trust is no longer serving needs effectively. This may occur because the trust's income is no longer sufficient to meet the beneficiaries' needs given low interest rates, or perhaps because the shifting estate tax exemption unwittingly caused a decedent's assets to flow entirely to a Bypass Trust, leaving the surviving spouse with no outright assets in his/her own name. While in some cases an income problem can be solved by just changing investments, in other scenarios that may not be enough, or some custodians or corporate trustees don't certain types of income investments like MLPs. In some cases, this can be solved by converting the trust into a unitrust to gain access to greater "income" cash flows. If the goal is to access principal, and the scenario is a deceased spouse who died recently and left funds to a Bypass Trust, the surviving spouse can elect against the Will to receive a statutory share of the state; in other situations, an agreement amongst all the beneficiaries to allow further access may be possible by amending the trust, although it's often difficult to line up all the trustees. 

Growth and Austerity - This article by Mark Tibergien in Investment Advisor is not about European growth and austerity, but a look at how to effectively balance growth of revenues with limiting business leverage and managing expenses in an advisory firm. Tibergien notes that costs are rising faster than revenues in advisory firms right now, as demand for staff advisors pushes up compensation, regulatory costs mount, and productivity growth slows. Details of the recent "Mission Possible III" study show how overhead expenses per client have been growing, with a breakdown of the biggest categories (non-professional staff pay and office/equipment expenses) and smallest (marketing and information technology) providing the strong reminder that in the end, financial advising is a people business (where the costs of staff people dominate the expenses of the business). Tibergien notes that the largest firms (e.g., $5M + of revenues) often have lower expense ratios thanks to some efficiencies of scale; nonetheless, smaller firms too can focus on more scalable solutions, managing proactively for profitability, and focusing more clearly on optimal clients and the right processes, procedures, and solutions to deliver to them.  

Smaller Pieces Make A Bigger Pie - This article by Eliza Depardo and Dan Inveen of FA Insight in Investment Advisor magazine looks at an interesting phenomenon - across all stages of development, better-performing advisory firms distribute equity more broadly among their team members. The basic implication - distributing shares may make the founding owner's slice smaller, but it makes the pie bigger, and as a result transferring shares is as much about creating value as it is cashing out on the value. Notwithstanding this, the FA Insight results suggest that in the aggregate, owners are retiring out of firms faster than firms are adding new owners, indicating that ownership is concentrating on average even while the most successful firms distribute ownership more widely. However, the results do show that the most common path to succession is increasing to transfer ownership to an existing employee, as opposed to admitting an outside owner. The data also shows a wide range of methods to fund equity transitions, from cash up front (which may involve private financing), to long-term financing by the firm itself, to contributing a book of business.

Pursuing Practice Excellent: The Advisor Perspective - This article from Investment Advisor magazine reports out on some of the initial results of the joint Investment Advisor Group / ActiFi research study on practice management, which examined both advisors, and the vendors who serve them, to determine where the needs and gaps are in the advisor practice management space. The results share some striking statistics; for instance, 86% of advisors measure business success by revenues (notably, not profits, and only 37% measure expenses!), while 80% measure success by client satisfaction, and only 44% measure by investment performance (and only 13% by number of financial plans); the most needed areas for advisor help include prospecting and client acquisition (71%), improving client communications (61%), and creating differentiation (57%%); the most valuable training for advisors from their vendors is specific training on how various solutions may apply to the firm's/advisor's specific situation. Notably, by far the most common deliverer of practice management support was broker-dealers, nearly tripling the support that custodians provide.  

Investing for Retirement: SPIAs, TIPS, Stocks and the 4% Rule - This article by Joe Tomlinson on Advisor Perspectives examines the impact of using SPIAs in lieu of bonds to supplement a portfolio spending strategy. The evaluate and compare strategies, Tomlinson suggests that outcomes need to be measured by not only their probability of failure, but also how quickly they fail and/or the magnitude of failure. For instance, as discussed previously on this blog, the lowest risk of failure is not always the best strategy; if you live to age 95, it's far worse to run out of money at age 75 than age 94 1/2, even though both are "failures" to fund all the way to 95. Tomlinson measures this by looking at the magnitude of "negative bequest" the client would have needed to fund remaining retirement goals until death had the portfolio not depleted already. With this framework, Tomlinson attempts to evaluate the value of stock/bond portfolios, versus TIPS, versus SPIAs, using current market rates for all the available investment options. As expected, use of SPIAs shows some trade-off between future legacy bequests and current income; notably, though, the results counter-intuitively show that SPIAs perform significantly better than TIPS, implying that SPIAs might actually be better in lower return bond environments!

Why MLPs Belong In Your Portfolio - This article by Geoff Considine on Advisor Perspectives presents a compelling case for why Master Limited Partnerships (MLPs), which generally invest in ownership and operation of energy infrastructure (like pipelines and energy storage facilities), should be used more by advisors in client portfolios - starting with the fact that they are providing a 7% yield with comparable or less volatility than equities! Considine provides a detailed explanation for what MLPs are, their returns, volatility, and correlations to other asset classes over the past several decades from many of the most popular MLPs, and some examples of MLPs to consider. Ultimately Considine makes the case that MLPs could have a role in both high income/yield portfolios, and as a diversifier and return contributor to a more standard diversified total return portfolio with as much as a 10%-20% allocation, although they do have some unique tax considerations to consider (both due to pass-through partnership treatment in taxable accounts, and because MLPs may generate unrelated business taxable income {UBTI} in retirement accounts).

The Heart of the Matter - In his weekly missive, John Hussman gets right to the heart of the matter about what's wrong in the current economic and investment environment - "a warped financial system, both in the U.S. and globally, that directs scarce capital to speculative and unproductive uses, and refuses to restructure debt once that debt has gone bad." Hussman believes that the US has now entered recession (which will be confirmed with a few more months of data), in large part because we never addressed the problems from 2008; by providing an ongoing backstop to bondholders from the US government, instead of wiping out bondholders and protecting depositors, the pattern is set to continue. To get back on the right path again, Hussman outlines key steps to change course - at a fundamental level, but ensuring the better allocation of capital in the economy by allowing bad investments to work out badly so the good ones are rewarded.

Harnessing The Power Of Trust - This article from Bob Veres' website is an excerpt from his Inside Information newsletter (available at a discount when you subscribe to The Kitces Report as well!) summarizing some of the keynote sessions from the recent FPA Retreat conference that centered on trust. The article explores presentations, including: Margaret Heffernan, author of "Willful Blindness - Why We Ignore The Obvious At Our Peril", who suggested that advisory relationships should be framed less as an expert/novice dynamic and more as a "thinking partners" interaction; psychologist Maria Somers who explored the challenges of non-adherence (when clients fail to follow the advice you've given them), noting that in reality non-adherence is the norm and that advisors should focus more on how to move clients through the change process to the point where the clients will be ready to follow the advice; and psychologist and coach Courtney Pullen, who looked deeply at what it is that really builds trust, noting that we often ignore the importance that competence plays in the process.

The Art Of Breathing: How To Handle The Overwhelm Of Being A Financial Advisor In 2012 - This article by Abby Salameh from RIABiz is a kind reminder of the importance of taking a moment for ourselves - especially if you're a classic Type A entrepreneurial personality. Simply put, by forever trying to cram more into the day and pushing harder for the highest level of productivity, we become overburdened and burn out. So what can you do? Salameh suggests a good starting point is to take a step away from the hand-held device. In today's world, we've set unreasonable expectations on our own time; most problems we think we have to answer really have to be answered that quickly. So set a policy for getting back to clients with a reasonable expectation, like "just" returning every call within 24 hours. Delegate more. Put your phone down when you are in a meeting or trying to complete a task. And sometimes, just take a deep breath or two. 

I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!


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