Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts off with a discussion of the latest shot fired in the SRO debate, as BCG and the Financial Planning Coalition respond to the latest FINRA estimate of SRO costs. From there, we look at three significant articles on retirement income planning, including: the latest thoughts from Bill Bengen showing that the 4.5% withdrawal rate is still working just fine, even for a 2000 retiree; an article from the Journal of Financial Planning showing how holding several years of the portfolio in a cash reserve INCREASES retirement failure rates; and a discussion from Bob Veres in Financial Planning magazine about whether we need to change our retirement spending assumptions. From there, we have a number of interesting markets and investment pieces this week, including highlights from James Montier's opening keynote speech from CFA Institute earlier this month, a look at how 'adaptive' asset allocation holds more promise than traditional strategic allocations, a prediction from Mauldin that Germany is waving the white flag and clearing the way for the ECB to print Euros to solve the Eurozone problems, and ongoing worries from Hussman that we may be dancing at the edge of an investing cliff. We wrap up with three interesting articles: a scathing 'anonymous' insider letter to Mark Zuckerberg shining a light on the investment bank realities of the IPO marketplace; an article by Angie Herbers about how the greatest problem in most advisory practices is the owner (and how to better get out of your own way for your firm's success); and tips for stressed-out advisors to try to (re-)gain a hold of some balance and efficiency in their practices. Enjoy the reading!

Weekend reading for May 19th/20th:

FINRA Comes Up With Cost Projections For Its SRO And The CFP Board Blasts Them - This article from RIABiz summarizes the latest news in the SRO debate: the recent release of FINRA with its own cost estimates to serve as an SRO, with numbers dramatically lower than those put forth last year by the Boston Consulting Group in a study commissioned by the Financial Planning Coalition (and other allies). FINRA has sharply criticized the BCG study for "pulling numbers out of the air" by completing projections without consulting FINRA, by the CFP Board and BCG strike back suggesting that FINRA's numbers are the ones pulled out of thin air, as the BCG study was a 30+ page thorough analysis, while FINRA's estimates where simply disclosed on 2 pages with no supporting information or assumptions. The article walks through BCG's analysis of the significant differences between their study and FINRA's estimates, noting that FINRA excluded staffing costs while ramping up, made generous productivity assumptions for examiners, and appears not to have fully included overhead costs for managing a larger organization.

How Much Is Enough - This cover article for Financial Advisor magazine by Bill Bengen explores the currently landscape of the safe withdrawal rate research, asking whether the 4% rule - now the 4.5% rule in light of subsequent research - still holds up. Bengen starts by comparing how the worst-case retiree from the historical research (starting in 1969) would be faring comparing to a 'current' worst-case year-2000 retiree, noting that it appears the year-2000 retiree is still doing much better than the 1969 retiree. By year 12, the 1969 retiree was already up to a whopping 12.5% current withdrawal rate (which was only barely bailed out by the monster 1980s bull market), while the year 2000 retiree is "only" up to a 5.9% withdrawal rate now, thanks in large part to far more modest inflation. Of course, Bengen notes that there are still 18 years left for the 2000 retiree, and current high valuation suggests that there is still a tough road ahead; with valuation levels comparable to 1969, if we grafted the 1969 retiree onto the current 2000 retiree, the money would run out in the 28th year (out of 30). Nonetheless, Bengen's conclusion is that, to say the least, the past 12 years certainly have not broken the 4.5% safe withdrawal rate. However, if the current withdrawal rate exceeds the original rate by more than 25%, taking some pre-emptive action may be prudent.

Rethinking Distribution Planning - In his monthly column in Financial Planning magazine, Bob Veres asks the question "how well do our [retirement] models fit actual [client] behavior in retirement?" Veres notes research by financial planner and outside-the-box thinker Jim Shambo, who points out that inflation for retirees is materially different than non-retirees. At the same time, the composition of expenses themselves seems to change through retirement (a topic discussed previously on this blog), and client-specific circumstances often have a greater impact than any of these more-finely-tuned assumptions. Ultimately, this raises significant challenges for retirement planning - if we're underestimating inflation and late-retirement needs, we may be over-recommending early retirement spending, and non-inflation adjusted annuities could be very ineffective at maintaining spending power in later retirement.

Sustainable Withdrawal Rates: The Historical Evidence on Buffer Zone Strategies - This article by Walter Woerheide and David Ninagian in the Journal of Financial Planning explores the use of 'buffer zones' - essentially, cash reserves set aside to support spending in difficult investment years - and their impact on sustainable spending. The authors test buffer zones ranging from one to four years of withdrawals set aside in cash, where spending comes from the investment portfolio in up years, and from the buffer account in down years (replenished in a subsequent up year from the investment portfolio). Notably - and as suggested previously in this blog - the authors find that the buffer zone strategies are not helpful to supporting higher safe withdrawal rates. In fact, the results show materially lower success rates with the buffer strategies in most situations; the buffer strategies at best only helped in short time horizons (15 years), or all-bond portfolios (but not equity-centric portfolios), and with moderately high withdrawal rates around 6% (but not much higher, nor much lower). The results imply that in the end, there is less mean reversion than investors commonly believe, and that in the long run the drag of a low cash return gives up more than any timing benefits by trying to avoid stock sales in downturns.

The Flaws of Finance - This article by James Montier of GMO, published on Advisor Perspectives, is a summary of some highlights from his very popular talk on "The Flaws of Finance" at the Annual CFA Institute conference in Chicago earlier this month. Montier suggests that our problems in finance have sprung from a combination of bad models, bad behavior, bad policies, and bad incentives. This article in particular focuses on the bad models issue, emphasizing that, especially in the hands of "monkeys" a VaR model or CAPM can wreak a financial disaster. If you're interested in further highlights of Montier's session, check out the highlights summary from Bob Seawright, or view a recording of the session in its entirely from the CFA Institute.

Adaptive Asset Allocation: A True Revolution in Portfolio Management - This article by Adam Butler and Mike Philbrick on Advisor Perspectives explores the problems in Modern Portfolio Theory that emerge with poor inputs (producing a "garbage in, garbage out (GIGO)" result), and how to change portfolio construction to address these problems. The article makes the point that returns vary over time, volatility varies, and that momentum exists, and that consequently portfolios should be adjusted over time to reflect this. The authors proceed to show how volatility-weighted portfolios (that update and adaptive as volatility changes) can enhance returns and reduce risk, while volatility-weighting with just the subset of asset classes with the best momentum can produce substantially higher returns. Overall, the article suggests that the future of MPT will need to proactively account for these factors, rather than making the simplifying assumption that they don't exist.

Waving the White Flag - In his weekly letter, John Mauldin notes that this past wave, Germany has "waved the white flag" to concede that the ECB will have to print extraordinary amounts of money to maintain the Eurozone, suggesting that while Germany is terrified of inflation, they're even more terrified of leaving the Eurozone. Mauldin also explores the problems in Spain - with the potential to be far more of a disaster than Greece, as the Euro can survive without Greece, but Spain is another story! Mauldin also notes that ultimately, contagion fears don't even end with "just" Spain, but with France, which has its own deficit problems that are growing, and a banking system that may be both too big to fail and too big to save - at least, unless there is an extraordinary ECB intervention.

Dancing at the Edge of a Cliff - In his weekly missive, John Hussman emphasizes once again the elevated risks of the current environment - a dangerous confluence of high valuations, deteriorating market internals, and the coincidence of multiple risk warnings that independently are concerning but jointly are exponentially more so. Hussman suggests that right now the markets are addicted to "Hopium" and cannot seem to let go of Hope, even as the situation turns more negative, as highlighted by recent comments from noted economist (and former NBER president) Martin Feldstein. Hussman also provides some interesting insights into JP Morgan's trading debacle, noting that ultimately every such disaster, from JPM to the downfall of AIG, Lheman, Barings Bank, etc., is caused by a combination of leverage, mismatch (long and short positions that don't perfectly offset), a lack of transparency, and a sudden absence of liquidity. 

The Facebook IPO: A Note to Mark Zuckerberg - This article from Dan Ariely's blog publishes an 'anonymous' letter from someone in the banking industry, addressed to Mark Zuckerberg, that walks through how Wall Street really makes money from a company's IPO. The letter emphasizes that while Facebook negotiated down the commission the investment banks would charge for the IPO, it still pales in comparison to the money that the investment banks and their 'friends' make by taking IPO shares and re-selling them to the public immediately thereafter on the IPO pop - pocketing the difference themselves, including so-called "Greenshoe" shares that the banks have the option to purchase and re-sell in the first 30 days after the IPO. Overall, the article paints a harsh picture of how Wall Street really makes money off IPOs, and although it doesn't state it directly, also raises serious questions about why anyone would want to buy the Facebook IPO shares immediately after they start trading. Although given the weak appreciation in Facebook shares so far today, maybe investors got the message after all.

The Virtues of Self-Importance - This article by practice management consultant Angie Herbers in Investment Advisor magazine shows that ultimately, advisors have to focus on themselves, because the actions they do and don't take are the ones that determine the long-term outcomes of the firm. Herbers notes that this isn't only in terms of the successes, but also the failures; ultimately, for better or for worse, all the problems in an advisory firm stem from the advisor principals, and sometimes the best thing they can do is get out of the way to really give their employees a chance to succeed (for themselves and the firm). Otherwise, the firm becomes dysfunctional, as the principal demands everything 'now', creates unrealistic expectations that doom employees to fail, tries to hire 'star' employees to fix the problem, and then fails further when the star employees still can't be found to meet unrealistic demands. Herbers advisors that ultimately, owners need to be a coach, not a boss, have realistic expectations, don't pigeonhold employees, and let the employees do the jobs their way (so they can play to their own strengths and weaknesses) for the firm's overall success.

5 Ways For Stressed-Out Advisors To Build A More Efficient Practice - This article from RIABiz gives 5 straightforward suggestions for how advisors can get better control of their business and their lives. The starting point is to focus your time on what you like to do, and delegate the rest to your staff, which also gives them an opportunity to step up and take on new responsibilities. Second, really use your CRM to manage what's going on in your office and with your staff. Third, leverage your resources - in particular, what are you trying to reinvent that your broker-dealer, custodian, or other vendors and business partners, have already done for you? Fourth, systematize your communications so you're not stuck in a reactive whirlwind all the time. And fifth, get mobile with tablets and smartphones so you can make the most of your time even if you're not in the office. The real takeaway here is that while we tend to focus on a lot of high level growth plans and strategies, taking 'simple' steps like these can often go just as far - not to mention clearing the way for you to really be more strategic in your growth from here.

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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  • Wednesday, June 6th, 2012
    Cash reserve strategies that hold aside several years of spending to avoid liquidations during bear markets are a popular way to manage ... kitces.com | Nerd's Eye View

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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Tuesday, March 10th, 2015

*Understanding Longevity Annuities and their Potential Role in Retirement Income *The Impact of Valuation-Based Asset Allocation on Retirement Income *Future of Financial Planning in the Digital Age @ FPA San Francisco

Wednesday, March 11th, 2015

*CPWA Training on Retirement Planning @ IMCA

Wednesday, March 18th, 2015

*Setting a Proper Asset Allocation Glidepath in Retirement *Safe Withdrawal Rates: Mechanics, Uses & Caveats @ FPA Greater Kansas City