Weekend Reading for Financial Planners (Jun 7-8)

Posted by Michael Kitces on Friday, June 6th, 1:51 pm, 2014 in Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts out with a cautionary warning from both FINRA and the SEC that this year will be one of heightened scrutiny on cybersecurity issues, and that advisors large and small will be held accountable for the quality of their protections of firm and client data... and that there may even be a few firms that will be "made an example of" with enforcement and fines for especially lax security. On the other hand, a separate article also notes that more generally, FINRA is acknowledging that its regulatory requirements may be getting too burdensome for small firms, and that some kind of relief may soon be coming as the regulator shifts to a more surveillance-based (rather than examination-based) approach.

From there, we have several practice management articles this week, including advice from Mark Tibergien on the importance of trying to control what you can control in attracting and retaining employees (while also recognizing what may be beyond the firm owner's control), some insight from Angie Herbers on the importance of having not only a long-term 'voluntary' succession plan but also a plan in place for how to handle a more sudden unexpected succession event if there is an unexpected death or incapacitation of the firm owner, and a look at the challenges that advisors face when they consider breaking away from a wirehouse and going independent (from the time and stress costs, to the "leap of faith" that if the advisor leaves to go out on their own, that clients will follow).

We also have several investment-related articles this week, from a roundtable looking at strategies to manage against the risk of rising interest rates (and whether it's even necessary to do so), to a second article that looks at whether annuities might be an effective bond substitute to manage a fear of rising rates, to a discussion of whether REITs still have a place in the modern portfolio given their significant volatility over the past decade. There's also an interesting article looking at strategies to manage our behavioral biases, which are a challenge for clients but can be as relevant (and challenging) for advisors in their own investment process too.

We wrap up with three interesting articles: the first is some guidance for advisors who have started a new practice and are struggling to work through "the gap" between where their business is during its initial stages and where they want and aspire it to be (which requires no small amount of patience and perseverence!); the second is an interview with financial advisor Ron Carson about the issues he sees in the industry, from the importance of fee transparency to the concerning lack of succession and continuity planning that advisors have failed to put in place to protect their clients; and the last is some professional and career advice from advisor and blogger Barry Ritholtz about his own unusual path in finance, affirming the importance of continuous hard work and a recognition that "once in a lifetime" opportunities come more often than we may realize, but only help if we're ready to take advantage of them when the time comes. Enjoy the reading!


Weekend reading for June 7th/8th:

Cybersecurity Crackdown: Where SEC, FINRA Will Strike - This article highlights what appears to be increasing scrutiny from both the SEC and FINRA on cybersecurity, and a concern about whether advisory firms (both large and/or small) have sufficient cyber defenses to protect client and firm data from potential hackers. Both regulators have explicitly listed cybersecurity as one of their top priorities this year, and an anticipated to be focusing on it during examinations, with an expectation that there may well be a 'message' case or two where the regulators apply fines and enforcement actions to make examples of firms doing an especially poor job. And the regulators have been beefing up their capabilities to conduct such assessments; in fact, IT specialists are now beginning to accompany legal examiners during RIA exams! Notably, the concerns are not merely about overt threats like a hacker taking over a client account, but also more subtle threats like malware getting onto an advisory firm's computers that lead to a breach of client data, or even insider risks from rogue employees that help hackers to infiltrate. Focal points during exams may include a look at a firm's information security, policies on cybersecurity prevention and monitoring, plans for how the firm would respond to a cyberattack that led to lost information or identity theft, and how the firm handles training and vendor access to the firm's IT systems (as well as the vendor due diligence process). And consultants warn that small advisory firms should not expect special treatment just because they're small, and in fact they may even be more focused upon given that the SEC has separately been looking to extend examinations this year to a large number of small firms that have never been examined before. In the meantime, expect to see continued guidance from the regulators themselves about what is expected from firms to remain compliant on cybersecurity issues.

FINRA Looks To Ease Burden On Small Firms - A top official with FINRA this week is acknowledging that the compliance challenges small firms are facing is concerning, and that FINRA is exploring ways to make oversight more flexible and less of a drain on a firm's resources. The issue is gaining visibility against a backdrop of the declining number of firms overall, down to about 4,400 from more than 5,000 a decade ago. Initiatives that FINRA is considering include easing back on intensive exams for small limited-purpose broker-dealers, better coordination of examinations with the SEC (including not doing a full-scale FINRA examination on a firm that was just recently examined by the SEC), and a shift from examination-based oversight to a more surveillance-focused approach (ostensibly supported by the proposed CARDS data-collection program).

Managing Employees Is A Chemistry Experiment - In this Investment Advisor article, practice management guru Mark Tibergien highlights the significant challenge of hiring and managing good employees, especially ones who can someday become a successor for the advisor. As Tibergien views it, the reality is that firms will have turnover, and that there are many employees who will always view their position as just a job and nothing more; in turn, the advisor's goal should be to identify which employees actually view their work as part of a long-term career, to make a better decision regarding which employees the firm and advisor should invest into. For those employees, Tibergien suggests that departures typically only depart for one of a few reasons: (bad) culture, mismanagement, (poor) pay, or a true desire to do something else somewhere else. While the last point can't be controlled, the rest can; by offering employees a compelling future, opportunities for growth, a positive environment, and a fair reward, most employees can be retained in the long run to ensure a legacy for the firm. In the end, Tibergien gives some further tips on how to evaluate and manage these elements, and encourages firm owners to supervise the elements under their control, and try to develop techniques to ferret out the uncontrollable elements that may lead to problems down the road.

Fire Sale: Leading Your Firm From Beyond the Grave - In this Investment Advisor article, practice management consultant Angie Herbers tackles the difficult issue of how advisory firms should plan for unplanned emergency succession transitions, where an owner unexpectedly passes away or becomes incapacitated and the firm has no designated successor. Herbers suggests that ultimately, the best plan is the one drawn up by the advisor themselves while they're still healthy, in no small part because the advisor can actually think rationally through the situation ahead of time, while in the moment staff will likely be stressed and distracted (and in general, it's hard to anticipate how everyone will react in such a situation). Accordingly, the emergency transition plan should detail exactly what key people should do, written in a simple and straightforward manner that will be easy to follow (e.g., a checklist), highlighting the following areas in particular: realize that successor owners will be going through their own process of grief and stress, and as a result will tend to either freeze and do nothing, or try to over-control the business and implement far too many changes at once and quickly, when often the best course of action is to change little in the first year and just let clients adjust; include a recommendation in the succession plan for the successors to get grief counseling (it will be an important and valuable reminder for them!); if there's no internal successor that will be able to step up, make an arrangement with an outside successor, but make sure any junior advisors are informed of the plan and that the owner doesn't think they're ready to run the firm (at least not yet) to avoid unhappy surprises later; caution successors to limit outside advice to avoid being overwhelming with conflicting guidance (if some advice is necessary, get one quality and qualified attorney or consultant to help); reminder successors that keeping and servicing clients is still first and foremost (hopefully obvious, but a helpful reminder in a stressful situation, and bear in mind that clients may have to be 're-sold' on the firm under new leadership!); and make sure your spouse is aware of the plan and buys in ahead of time, as there's nothing that can make a smooth transition to a successor unravel faster than a disgruntled spouse!

If You Go Indie, Will Clients Follow? The Great Leap of Faith - This article looks at some of the latest trends of large-firm advisors breaking away and going independent. While the last wave of breakaways departed primarily due  to the damage the 2008 financial crisis did to the brand of their firms, the latest wave of breakaways appear to be focused on new elements, including fiduciary concerns, a rethinking of fees,  a desire to craft a deeper specialty or niche, an eye on succession planning, and a desire for a lifestyle change. At the same time, researchers suggest that current firms supporting breakaways focus too much on things like a broker-dealer or custodian's technology, culture, and payouts, and not enough on the broader range of issues breakaway advisors face, including the stress of transitioning clients, how long it takes to be up and running again, and the ability to mitigate the financial, personal, and time costs of breaking away. In turn, some independent firms are finding that the best path to recruiting is actually to tackle these issues head-on, and assuage advisor fears like whether clients will move too (they will). Nonetheless, the common theme for most advisors looking to break away is that in the end, it is a stressful process to transition, and still amounts to a bit of a "leap of faith", even though many seem to note after the fact the clients really did follow and they can't believe they waited as long as they did to make the change.

Investing For Rising Interest Rates - This roundtable interview from the Journal of Financial Planning explores the challenges for advisors and their clients in making good investment decisions in the face of growing concerns about the potential for rising interest rates. Out of the gate, though, the panelists note that in the end, the fears about the consequences of rising rates may be overblown; while it may be a shock to clients that bonds lose money at all, bond funds of moderate duration may still only lose 5% (which recovers over time as the bond approaches maturity and the ongoing coupon payments are made) over a time period where a stock market crash could be many multiples of that loss. Overall, in the rising rate period from 1950 to 1981, the 10-year Treasury total return was 2.2%, which is far less than the 10.9% average annual growth rate from 1981 to 2013 when rates were declining, but is still ultimately a positive a bond return. And investors fearing rising rates can own shorter-term bonds with less duration risk, and the potential to more quickly roll over maturing bonds into new ones at higher rates. More broadly, the panelists note that in the end, the primary role of bonds in many portfolios is less about generating returns at all anyway, and more about being the shock absorber for equities, which is still relevant even with currently-low-and-potentially-rising rates. And for retiring clients, there is still the potential for bonds to provide dedicated and targeted retirement cash flows from coupon and maturity payments, allowing clients to further manage through (or simply not need to worry about) any interest rate volatility in the interim. For advisors still worried about rising rates, there's always an option to shorten duration (though watch out for how much yield you might give up waiting for rates to rise!), and some are focusing more on individual bonds that can be held to maturity rather than bond funds that may have to continue to sell bonds that are down and reinvest to maintain duration as interest rates rise. In the meantime, though, it's probably not a bad idea to at least be explaining the dangers and consequences of rising rates to clients ahead of time, so that whenever the rates do start to rise, clients will be more prepared for what happens as bond volatility rises as well.

Best Income Strategy: Bonds Or Annuities? - This roundtable from Financial Planning magazine looks at the trade-offs between today's low interest rate environment for bonds, and the potential benefits of purchasing an annuity instead. First and foremost, though, the panelists caution about taking too strong a view about the danger of rising rates - the Fed has noted that it will keep rates low as long as necessary, and many advisors who have been cautioning that Fed policy will lead to inflation and rising rates have been saying so since 2009, yet rates have remained low (and in Japan, such lows have persisted for 15+ years!); more generally, investors, advisors, and economists all seem to have a rather poor track record for predicting the timing of a change in the direction of interest rates, and in fact if deflation sets in bonds could still be a favorable performer, even from here. For those that still want to manage against the danger of rising rates, one advisor suggests the use of CDs for clients, which can be withdrawn and reinvested at higher rates for an "early withdrawal" bank penalty that may be less than the duration risk of comparable bonds. For those concerned that low bond yields may erode purchasing power so much that a retirement portfolio can't sustain, there is some appeal to using annuities, though retirees may still wish to hold bonds "for now" and reinvest into annuities in the future if/when/as rates rise. Some advisors are looking at the potential use of Deferred Income Annuities (also known as longevity annuities) to specifically hedge longevity at a lower cost, filling in the intervening years with TIPS until the longevity annuity payments would begin. More broadly, though, it's important to recognize that in the end, annuities are primarily a longevity hedge, and as an insurance product they will not have a positive net present value - and in fact, shouldn't! - but if longevity risk (especially paired with a low-rate environment) is a client concern, the annuity can still be an effective solution. However, for clients who do want annuity protection, the best form of "annuity" is still the decision to delay Social Security benefits!

Is The Time Right For REITs? - This article by Texas Tech professor Michael Finke looks at the landscape for REITs, which were traditionally viewed as a potential buffer to market volatility given their stable rental income flows and underlying hard assets... until equity REITs dropped 32% in September of 2008 and another 23% in October, losing even more in value than the stocks they were meant to diversify against. Fortunately REITs have rebounded significantly since then - so much that some are wondering once again if it's time to take some risk off the table - but the underlying question still remains of what role REITs should (or shouldn't) play in the first place. Over the long run, though, REITs still have shown (only) a moderate correlation to equities (though 2008 demonstrated they're not necessarily an effective hedge in a bear market), and despite their 2008 fall the return on the FTSE NAREIT index has dramatically outperformed the S&P 500 cumulatively since 1990. Accordingly, the research still shows that including REITs in a portfolio appears to improve the risk-adjusted portfolio performance, and can also be a diversifier to bonds in a rising rate environment (as REIT returns have remained positive during all the rising rate periods of the past decade), though notably some of the REIT diversification value is lost in the fact that most "dividend" distributions from REITs are taxed as ordinary income and not qualified dividends (though their pass-through treatment also avoids the double taxation of corporations in the first place!). Unfortunately, though, REITs have been so popular in the past two decades that the typical spread between equity market and REIT dividend yields has narrowed from 6% to just over 2%, which suggests that REITs may not have quite the future tailwind they've had in the past. Nonetheless, the article remains relatively optimsitic about REITs overall, though there is still some concern about the lack of transparency for non-traded REITs in particular.

How Advisors Can Make Better Investing Decisions - In Research magazine, Bob Seawright looks at the latest recent update to the Dalbar Quantitative Analysis of Investor Behavior (QAIB) study, which once again showed that the dollar-weighted return of equity fund investors was dramatically lower than the time-weighted return of the S&P 500 (though as discussed previously, there are some flaws to the Dalbar methodology). But perhaps more striking from the research was its new conclusion that attempts to correct irrational investor behavior through education appears to be futile; investors do not make more prudent decisions after education alone, due to our wide range of persistent behavioral biases (nor does being aware of biases necessarily help us to overcome them). And while the Dalbar study is done in the context of investors, Seawright notes that advisors themselves are often prone to the same biases and problems, from overconfidence to herding behavior and more. Accordingly, the key - for both investors, and advisors - to overcome these challenges are to establish an investment process and structure that can address some of the biases. Tips from Seawright, drawing heavily on Daniel Kahneman's book "Thinking, Fast and Slow"  include: ensure that decision-makers have skin in the game; focus more on what goes wrong and why than upon what works; make sure your investment process is data-driven; be ceratin to read outside your own circles and interest to avoid confirmation bias; focus more on process than results; collaborate with people who have very different ideas; build in accountability mechanisms for yourself and your process; operate in a team with multiple perspectives; and before a big decision, conduct a "pre-mortem" that assumes a poor outcome and considers how it might have happened, to legitimate and empower the doubters to figure out the potential challenges (and how to solve them) ahead of time.

Don't Get Stuck In The Gap - This article on the XY Planning Network blog by (new) financial planner Matt Becker talks about the challenges of being a new start-up advisory firm, and struggling with "the gap" - that distance between where you are when you first start your practice, and how far it is to catch up to those you firms or advisors you admire and wish to emulate. Working through "the gap" can be daunting, whether it's trying to be active in social media but you don't feel like you have the followers/connections everyone else does, or you want to build a blog but no one is reading it, or you want to craft a great experience for clients but aren't certain how to deliver it, or are simply trying to figure out how to get that first client or few in the door. As Becker notes, the challenge for most - whether in the advisory business, or any entrepreneurial or creative endeavor - is that many people are so plagued by self-doubt that they give up too soon, often not recognizing the reality that those you may look up to probably went through the exact same challenges when they were starting, too. So how do you work through the gap? Becker suggests six key steps: get comfortable with the discomfort (it's just a realize you'll have to deal with!); keep taking action (be a doer, not a dreamer, and keep moving forward); do NOT try to do everything (instead, focus on what's working early on, and stick with it); commit to learning (there's always more to learn!); ask for help (knowing when and how to ask for help will make you stronger, faster); and know that you're not alone (no matter how much you doubt, remember that every successful person has been right where you are, too). In the end, the real question is not whether you're good enough right now, but whether you're ready to do the work to push through the gap and get to the point where you are.

10 Questions With Ron Carson - From the Journal of Financial Planning, this article is a "10 Questions" interview with Ron Carson, a financial advisor and founder of Carson Wealth Management and the Peak Advisor Alliance (amongst other businesses), about the major trends and issues he seems impacting advisors. One of Carson's greatest concerns in the current environment is the lack of succession planning for most advisors - a recent FPA study found that only 25% of advisors have a succession plan in place, and Carson suggests that number may actually be too high and that many of the succession plans advisors have aren't really executable (e.g., lack of funding, not fully documented, outdated valuation, etc.). And of course, the real issue is whether the succession plan provides continuity to the client, which Carson is even more concerned about; in fact, he advocates that this is one area where regulators actually should intervene, to require advisors have a more substantive succession and continuity plan for their clients (including a requirement to publicly show their clients their succession plan). Beyond succession planning, Carson also advocates strongly that advisors need to learn to delegate more (so they can free up their talent to serve clients, find new ones, and grow the business), the importance of fee transparency (it's crucial to building trust, though more transparency will push advisors harder to really show how they add value), and warns that many advisors may be underspending on technology and falling behind competitively. In fact, Carson suggests that in the current landscape, firms need about $1B to compete effectively, and that those who aren't there need to "build it, borrow it, or merge it" to get there as aggressively as they can. At the same time, Carson cautions that building good culture in your firm - especially as an advisory firm that's all about people - is absolutely crucial to long-term success, as even the best strategy in the world can't be executed without a positive culture.

My Unusual Career Path In Finance - In this article, investment/finance blogger and advisor Barry Ritholtz talks about his own unusual personal path through the world of finance, starting out as a lawyer, then switching to the investment industry only to be downsized out of his job on his first day (the firm, a little company called E*Trade Group, declared they were relocating to California to focus on online trading, but Ritholtz had family obligations and couldn't move), then switching to a prop trading firm, and eventually starting a daily practice of jotting down notes every morning to organize his investment thoughts. Yet as it turned out, Ritholtz found he had a knack for writing (perhaps his law school education?), and his investment notes started getting shared around - first by fax (as it was the mid-1990s), then on a basic website (Yahoo's Geocities around 2000), then as a "blog" (Typepad) in 2003, and ultimately to his own website in 2008... which in turn has exploded into more media and writing opportunities, from television to radio to newspapers and books. Ritholtz wraps up with a great set of "life lesson" takeaways, including: be multi-talented; work harder than everybody else; find something you're good at, and hone the skill; read voraciously; meet as many people as you can; develop a specialty; and recognize that "once in a lifetime" opportunities come along more frequently than you imagine, but you have to be prepared for them. Of course, he notes that it doesn't hurt to be a little lucky, too.


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!

In the meantime, if you're interested in more news and information regarding advisor technology I'd highly recommend checking out "Bill Winterberg's "FPPad" blog on technology for advisors.

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Monday, July 28th, 2014

Setting A Proper Asset Allocation Glidepath in Retirement Social Security Benefits Planning for Couples @ Private Event

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