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Weekend Reading for Financial Planners (Sep 22-23)

Posted by Michael Kitces on Friday, September 21st, 7:30 pm, 2012 in Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts off with a look at how fiduciary rulemaking progress has slowed so much that any real change may now be years away at best, a discussion of how (despite lack of progress on fiduciary minimum standards) the future of advice may include a small number of mega-firms that are really building a focused, holistic and client-centric approach to advice, and a somewhat disturbing article suggesting that financial planners are becoming a target for cybercrooks that are trying to steal client money by sending advisors fake email transfer requests. From there, we have a few interesting retirement articles, including an interview with Moshe Milevsky, a discussion from Wade Pfau looking at the immediate-annuity-versus-systematic-withdrawal debate, and an analysis of median income for households over the past several decades that shows how retirees are actually faring the best of any age group. We also look at an interesting Journal of Financial Planning article about how to better evaluate cash value life insurance illustrations, a discussion whether it really pays to go to cash waiting for interest rates to rise, and a look from Morningstar at how as more and more people adopt indexing approaches new opportunities may be emerging for active managers. We wrap up with two lighter articles, one with tips on how to get more productivity time back with some good email management tips, and an intriguing discussion of how, in light of the fact that even people who now do what they love often found that path only after a period of time and some difficult early years, "follow your passion" may be bad career advice for Generation Y and that instead we need to paint a more nuanced picture of career paths that acknowledge the (inevitably?) difficult early years. Enjoy the reading!

Weekend reading for September 22nd/23rd:

Time Running Out On Fiduciary Proposal - This article notes that the push for a fiduciary uniform proposal may be dead, or at best stalled for years (which is still effectively a death sentence in Washington!). The key issue appears to be a general challenge with the SEC to manage the overwhelming amount of new regulations required by Dodd-Frank, and an increased concern from the SEC about putting forth any rulemaking without a thorough cost-benefit analysis after the SEC had a new rule on proxy access vacated recently by a Federal court due to insufficient economic analysis (otherwise, whoever is on the "losing" side of fiduciary reform will simply challenge the SEC on the same grounds). Yet it's unclear how to even quantify the benefits of a fiduciary standard (although the costs are clear), and there is still a great deal of disagreement about what a proposed standard should really look like in detail or even what to measure. The end result is that ultimately there may still be some hope for a fiduciary standard, but it seems very unlikely to be revived or gain momentum anytime in the next few years.

Why Wirehouses, And Classic RIAs, Risk Losing Out To A Coming Oligopoly Of New-Model Holistic Firms - This article interviewing United Capital CEO Joe Duran looks at the emerging focus of firms on an overall holistic, "life management" model, and suggests that the space is positioned to be dominated by a relatively small number of big early players. Ultimately, this all tracks back to the idea that firms, like doctors and lawyers, need to evolve "from being providers of solutions to guiding on the use of information." On the other hand, while industry expert Philip Palaveev agrees with much of the direction - including consolidation, increased competition, higher client expectations, and the importance of branding and marketing - Palaveev questions the conclusion whether a small number of mega-firms will really dominate the industry. For many cutting edge financial planning firms, what Duran describes is probably what they already deliver to clients for the most part, but Duran suggests that ultimately consolidation will still lead to a limited number of mega-firms that dominate the space; Palaveev, on the other hand, suggests that the nature of individualized advice from individual advisors will still lead to a great deal of ongoing fragmentation. 

Cybercrooks Fool Financial Advisers To Steal From Clients - This article from USA Today highlights the unfortunate emerging trend of wire fraud, that is specifically being targeted at advisors and their clients. The basic gist - the cybercrook sends an email to the advisor requesting a wire transfer, either from a fake email account that appears similar to the client's email address or sometimes from the client's actual email account that has been hacked. The advisor completes the transfer request, and by the time anyone realizes it was a fake request, the money is gone. Thus far, most incidents have been caught either by the advisor realizing the suspicious email or source, or due to a follow-up phone call for confirmation or question that revealed the transfer request was fake. The bottom line - be aware that your clients may be a target, and fooling your firm is the intended means for the theft.

Five Good Questions For Moshe Milevsky - This article is a Q&A style interview between Bob Seawright and retirement planning expert Moshe Milevsky. In the discussion, Milevsky addresses the so-called "annuity puzzle" - why immediate annuities appear to be so appealing academically yet so rarely implemented by consumers - suggesting that it's no longer a puzzle why consumers don't use immediate annuities, and instead the issue is simply how to address legitimate consumer concerns through a combination of education, product design, incentives, and regulation. Milevsky also notes that current retirement income guarantee products are difficult to maintain, yet implies that they may still be a relatively good deal in an extended low interest rate environment even at current pricing, and suggests in general that there is more value in guaranteed withdrawal benefits than guaranteed death benefits. Milevsky also puts forth an interesting analogy about how retirees can consider balancing out spending with longevity risks - implying indirectly that allowing for a lower standard of living at/beyond age 100 might be a very reasonable, rational plan to have, simply as a trade-off decision.

Your Clients' Toughest Retirement Decision: The Debate Between Systematic Withdrawals and Immediate Annuities - This article by Wade Pfau in Advisor Perspectives takes a good look at the current debate between systematic withdrawal plans versus single premium immediate annuities as an approach for retirement income, noting issues including the value of the historical record (is the US historical data still too short to draw any real conclusions?), the validity of research assumptions (what is the right time horizon for longevity, and will clients really stay the course in difficult markets?), potential advisor biases due to business models (does the AUM model tilt advisors towards systematic withdrawal solutions?), the impact of fees and taxes, and the role of potential fraud and cognitive decline (is annuitization a valid strategy to eliminate the risk of seniors in cognitive decline making poor decisions for themselves down the road?). There isn't necessarily a clear conclusion here, but the article is a good exploration of the issues.

U.S. Median Household Incomes by Age Bracket: 2011 Was a Bleak Year - This article from Doug Short on Advisor Perspectives looks at the latest data on median household income, with a deeper look into how income has trended across various age brackets. The most striking trend, by far, is that while seniors (age 65+) tend to have the lowest household real income, they have also experienced by far the greatest real increase in median household income over the past 44 years (as far back as the data exists), which are up over 100% in real income since the late 1960s; by contrast, most age brackets are up only 10%-40%, and those age 15-24 actually have lower real median income than the 1960s! More recently, the senior age bracket was the only one to experience a real increase in median income over the past decade (the worst were those age 45-54, whose real income declined 16.9% since a 1999 peak, although that is also traditional the peak earning age bracket), and in the past year most of the age brackets experienced a decline as well.

Bringing Real Clarity and Understanding of Cash-Value Life Insurance to the Marketplace - This article by Brian Fechtel in the Journal of Financial Planning takes a deep dive into how to evaluate cash value life insurance policies, noting that sales illustrations alone do not provide adequate information for assessing policies (in point of fact, nearly 20 years ago the Society of Actuaries stated "Sales illustrations [of life insurance policies] should not be used for comparative policy purposes"). Instead, Fechtel recommends an approach that deconstructs and then reconstructs the illustration data to better assess the true cost to available alternatives (such as buy-term-and-invest-the-rest), rather than drawing inappropriate conclusions from illustrations that ultimately are based solely on company-selected assumptions, not necessarily an actual expectation of future performance. As Fechtel notes, in the end the client buys the insurer's operating practices and future financial performance, not a non-guaranteed illustration. Ultimately - and unfortunately - Fechtel's approach may be more complex than what many planners have the means or tools to do easily for clients, but at least provides an interesting educational understanding and perhaps someday will be a template for a software tool planners can use.

Should Investors Avoid Fixed Income Securities When Interest Rates Rise? - This article by Craig Israelsen in Financial Planning magazine tackles the popular concern how to invest in anticipation of rising inerest rates. Israelsen took a simple approach to analyze the issue - he compared a well diversified portfolio that held bonds in years when the Federal Funds rate rose, to a diversified portfolio that liquidated its bonds and just held cash in years of rising rates. The end result - over the past 36 years cumulatively, the two approaches had virtually identical results. Getting out of bonds during rising rate years didn't help, although it didn't hurt either - essentially implying that on average in rising rate environments, bonds earned interest but lost principal and finished with a total return basically identical to the underlying cash return anyway. Clearly, if the investor held ultra long term bonds, the results would be less favorable - Israelsen assumed the Barclays (formerly Lehman) Aggregate Bond Index. But nonetheless, the article still makes the notable point that as long as bond duration is reasonable, maintaining exposure in bonds might not cause damage nearly as bad as some have suggested - although holding cash instead of longer term bonds betting on rising rates and having rates not rise, or even drop lower, will result in lower returns.

Taking the Road Less Traveled to Safety - This article from Morningstar Advisor makes the interesting point that as more and more investors migrate towards indexing (approximately $550 billion left actively managed US stock funds over the past 6 years, and approximately 60% of that landed in passive index vehicles!), more and more investors are subject to the volatility and vicissitudes of the markets - which in turn means that active managers who are really willing to deviate from benchmarks (but not abandon them entirely) to manage risk may become increasingly appealing. The key issue is that as more money concentrates in indexing, the diversification benefits actually decline, as returns of the market become increasingly dictated by overall asset flows to equities and not an efficient market process for the underlying individual stocks, and this has been witnessed in rising correlations and betas across all equity segments over the past decade. Accordingly, funds that are really active - as measured by their active share - create an opportunity to materially deviate from the benchmark and provide risk-managed value. The article then suggests a few funds that might fit the bill, including Amana Trust Income (AMANX), First Eagle US Value (FEVAX), GMO Quality (GQETX), and Sequoia (SEQUX), all funds that generally select a more concentrated list of high quality stocks and potentially accumulate significant cash holdings as well.

Get Your Time Back! - This article from the FPA Practice Management Solutions magazine has some nice tips for getting back some of the time you lose every day to the neverending onslaught of email - especially since too much email is not only outright time consuming, but distracting as we try to multitask it as well. The recommended solutions include unsubscribing to anything you don't really need to see/read, using built-in "rules" available in email programs to manage the email flow, check email at specific intervals during the day, training your staff to "cc" you less and only on what you really need to see, better prioritize what you respond to and when, and get your staff to help you if necessary! The article provides a few suggestions for other time management productivity tips as well.

Solving Gen Y's Passion Problem - This article takes a look at Generation Y - today's teenagers and 20-somethings - who are having difficulty entering the workforce, much of which is attributed to the fact that this generation grew up during a time when "follow your passion" has become pervasive career advice. Yet this implies that you should only do what you have a passion for on day one - despite the fact that many people who do what they love for a living actually arrived at that point only after a long period of unexpected and complicated paths. How can you truly have a passion for a prospective career before you've ever even really DONE it? The bottom line is that it's not necessarily a bad thing to pursue a passion, but the author suggests that we need to have a much more nuanced conversation that recognizes that the path is neither always easy nor clear, and that either way it's entirely normal for the early phases to perhaps be somewhat less pleasant, even if the final outcome is one you love. I suspect many experienced planners who (now) love what they do but look back on the difficulties of their business and career would find a lot of resonance in this message.

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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