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Weekend Reading for Financial Planners (Mar 24-25)

Posted by Michael Kitces on Friday, March 23rd, 6:24 pm, 2012 in Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition highlights some recent activity regarding fiduciary, from an surprising alignment between NAPFA, the FPA, and FSI against the latest Department of Labor proposals on fiduciary, to an article exploring how wirehouses may already be shifting their brokers towards fiduciary, and a profile of a former broker who suggests that the wirehouse model (at least in its current form) will be dead by the end of the decade. From there, we look at a review by Bill Winterberg of the latest iPad, along with how mobile apps are evolving in the RIA marketplace. On the investment front, there's an interesting new type of annuity that may be coming soon, which would allow advisors to attach an income guarantee to an investment account without tying up the entire account itself inside the annuity, an interesting article by Larry Swedroe suggesting that "buy what you know" is actually not a good investment strategy, and a striking look at the Wall Street meltdown in the financial crisis suggesting that the SEC's change in net capital limits for broker/dealers in 2004 may not have actually been to blame. We wrap up with a warning from Hussman that an army of angry Aunt Minnies may be signaling a market peak and the onset of a new bear market, and a much lighter piece pointing out that you can lose so much productivity by working long weeks that you'd be better off cutting back to 40 hours. Enjoy the reading!

Weekend reading for March 24th/25th:

As DOL contemplates stiff fiduciary-related penalties on advisors, NAPFA and FPA find rare concord with FSI - This article from RIABiz discusses the recent and 'surprising' alignment between NAPFA and FPA on the one hand, and FSI on the other, expressing concerns about the latest version of the Department of Labor's efforts to put strict fiduciary requirements on advice provided to retirement plan participants (including IRAs under certain circumstances). The alignment between the organizations has been surprising, as FSI has generally fought against a fiduciary requirement for brokers, while NAPFA and the FPA have supported it. Nonetheless, both organizations have expressed concerns that the penalties for fiduciary violations are so stiff, that advisors may avoid working with small accounts that wouldn't be able to afford the fees necessary given the legal exposure. On the other hand, Knut Rostad of the Institute for the Fiduciary Standard and Blaine Aiken of Fi360, along with Don Trone of 3Ethos, suggest that while it may be difficult to service small accounts, it will be possible, and that companies will step up and find a way if required to do so.

Wirehouses Minting Fiduciary Advisors - Or Are They? - This article from Registered Rep discusses a significant increase in wirehouses engaging outside firms like Blaine Aiken's Fi360 and Don Trone's 3Ethos to provide fiduciary training for their advisors; one wirehouse put 500 of its advisors through the Fi360 program last October, and the number of classes has doubled every year since early 2009. The recent drive for fiduciary appears to be some combination of anticipated fiduciary regulations coming in the future (whether from the SEC or the Department of Labor, or both), in addition to competitive pressures as RIAs continue to take significant market share from wirehouses. However, the article notes that while the wirehouses are training large numbers of advisors in fiduciary, they're being very quiet about it - perhaps because they don't want to expose themselves to even more fiduciary liability before they're required to. Nonetheless, whether due to regulatory or competitive pressures - or both - the wirehouses may be making a significant shift to prepare to go head-to-head with independent advisors in a fiduciary future... as predicted previously on this blog!

Breaking Ranks: Former Broker Turns Bomb Thrower - This cover article from the March issue of Research magazine is about "reformed broker" Josh Brown, of the popular blog "The Reformed Broker" and recent author of the "Backstage Wall Street: An Insider's Guide to Knowing Who to Trust, Who to Run From, and How to Maximize Your Investments" book. Brown is a former wirehouse broker who broke away to join an RIA, and now predicts that wirehouse broker firms will be gone in 10 years (at least from their current form; per the preceding article, maybe they'll all be fiduciaries under an entirely new business model!?). Brown doesn't just predict the demise of the wirehouse model, though; he also believes the "suitability" standard will fall, and that the mutual fund industry will be decimated by ETFs. The article goes on to share some of Brown's "insider" perspective on having been in a wirehouse, and why he thinks the model and its associated conflicts will not survive. 

Quickview: Should Financial Advisors Buy the New iPad? - This article by technology consultant Bill Winterberg on MorningstarAdvisor reviews the brand new iPad, and what it offers for advisors. Winterberg highlights three features: the high quality new display that will make applications really look beautiful (like presentations you share with your clients or marketing collateral); the 5-megapixel camera that will allow advisors to take a picture of documents to 'scan' them right into a paperless office system; and the 4G LTE connectivity that provides radically faster download speeds to load and stream content. Winterberg suggests the features are enough to warrant an upgrade from the original iPad, but the choice isn't as clear for iPad2 users; for those who haven't adopted tablets at all, Winterberg maintains that tablets are still valuable for advisors, but that they're not a replacement for a laptop, but simply a gap-filler between the office desktop and the home office computer.

Why RIAs Are Shunning Mobile Apps And Why... Others Are Still Placing Their Chips On An iPad Future - This article from RIABiz explores how actively vendors are rolling out mobile apps for advisors to use - either themselves or with their clients - despite the relatively slow adoption rate with advisors themselves. The primary inhibitors to adoption appear to be not only a general resistance to change, but lack of clarity from advisors about what the real benefit is. For instance, is the purpose to improve workflow for the advisory firm? Or communication and information for the client? Or to demonstrate tools and marketing for prospects? And can they be integrated effectively to show aggregated information the way planners like to report to clients? The bottom line is that while adoption of mobile apps has been slow, there is some increase in usage, and an expectation that the world is still heading for mobile apps means that vendors are still developing aggressively, in anticipation that advisor usage will catch up soon.

Newfangled Annuities Offer Benefits, Hold Risks - This article from Registered Rep discusses an entirely new innovation on the horizon, called 'contingent annuities'. The basic concept is that instead of tying your assets up in an annuity, you keep the money invested yourself, but pay a fee to the insurance company to provide an income backing, should the account balance ever be depleted - thus, the annuity's payout is only 'contingent' on depleting in the account in the first place. By engaging in such a structure, the contingent annuity will potentially be significantly cheaper than traditional variable annuities. However, thus far the only offering is from TransAmerica, and only for an internal program for the company's advisors, although it may become more broadly available later this year. The article highlights several ongoing difficulties with the product right now, from uncertainty about pricing and risk management for the insurance company, to regulatory questions about how such contracts would be overseen and by who. Nonetheless, the potential for attachment an annuity income guarantee at a low cost to an existing liquid investment account may be very appealing; stay tuned for more developments in the coming year, and except more insurers to jump on board if TransAmerica's initial offering is successful. For a more detailed discussion of these 'stand-alone living benefits' (including some other carriers rolling them out) see this article by William Byrnes on AdvisorOne.

Investing: 'Buy what you know' is a bad strategy: This brief article by Larry Swedroe, summarizing a recent Journal of Finance paper by Doskeland and Hvide entitled "Do Individual Investors Have Asymmetric Information Based on Work Experience?", looks at a basic concept - if "buy what you know" (as embodied by famous mutual fund manager Peter Lynch) is good advice, then do professionals who invest in stocks they work for and/or in their industry have more success? The answer is no, not even close; individuals trading 'professionally close' stocks had a negative alpha of 5%, and the stocks they sold outperformed those they bought by 4%/year. The results suggest that buying what you know may appease our behavioral tendencies for familiarity, actually leading to overconfidence; in other words, people might actually be worse investors in buying what they know because they inappropriately discount the risks and do themselves even more harm!

The Meltdown Explanation That Melts Away - This intriguing article by Bethany McLean for Reuters challenges the 'conventional wisdom' that the SEC's changes to the net capital rule for broker-dealers caused a spike in leverage of Wall Street firms that in turn led to the financial crisis. The article notes the source of the commonly cited statistic that many Wall Street firms dialed up leverage from 12:1 in 2004 to more than 30:1 by 2008, the reality is that actually many of the same firms had actually had leverage comparable to the 2008 levels at several other points in the past two decades, including points in the midst of the 2000-2002 bear market. And for some firms, their leverage levels were rising before they actually adopted the rule in the management of their own firms. The point of the article is not that leverage didn't exacerbate the financial crisis - that's still clearly the case - but it raises perhaps an even more disturbing question: if the high leverage levels that complicated the financial crisis were not the result of the SEC's 2004 rule change, why did leverage levels rise so far, and what was the actual cause. After all, if we don't understand the real causes that led up to the crisis, it's unclear how they can be prevented in the future!

An Angry Army of Aunt Minnies - In his weekly missive reproduced on Advisor Perspectives, John Hussman explores the current market environment, cautioning that the current combination of overvalued, overbought, overbullish, and rising yields is especially concerning and suggests extremely elevated market risks; the last time these signals all lined up was April 29, 2011, which proved to be the high for all of 2011 and the market experienced an intermediate plunge very shortly thereafter. Hussman notes that the economic signals are also bearish, although somewhat more mixed than the direct stock market indicators. Perhaps the most interesting part of this week's discussion from Hussman, though, is an exploring of market risk (earning gains or losses) versus tracking risk (beating or trailing a benchmark). Hussman notes that clients are often wary in the short term about being out of the market while it's going up, even when it may clearly be best in the intermediate-to-long run. So why not just participate, at least a little, until the market turns? Hussman points out that if your outlook for the market is already negative, participating from here leaves you no disciplined sell strategy about when to exit, as by definition your 'exit signal' is already present! Consequently, chasing the market to the top can participate more greatly in declines and be inferior to just not participating at all.

Why Working More Than 40 Hours a Week is Useless - This article from Inc magazine takes a look back at the productivity research of the past decade, noting that the 40-hour work week of the 1960s was not just a lucky coincidence. In fact, productivity research of the time showed, quite clearly, that it was an optimal amount of working time; simply put, on average you don't get many more widgets out of an employee's 10-hour day than you did from an 8-hour day, because of the declining productivity. And while the research was based on a more manufacturing-driven economy, it is arguably even more relevant in a world of professional services that requires an alert and active mind. This is not to say that short bursts of overtime and focused energy are bad - they can be very effective to meet a critical project deadline - but a sustained longer work week undermines the short-term benefits. The bottom line: working more than 40 hours a week may not be 100% useless, but are your 55+ hour weeks really as productive and sustainable as you believe?

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!

Michael E. Kitces

I write about financial planning strategies and practice management ideas, and have created several businesses to help people implement them.

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