Weekend Reading for Financial Planners (Sep 8-9)

Posted by Michael Kitces on Friday, September 7th, 11:46 pm, 2012 in Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts off with a surprising interview from Barbara Roper at the Consumer Federation of America, suggesting that given how the SEC is dragging its feet, perhaps FINRA would be the better solution for investor protection after all. Tying into the regulatory theme, we also look at Bob Veres' latest Financial Planning magazine column, suggesting that RIAs should come to the table with their own fresh proposals rather than waging a FINRA vs SEC battle, a recent study by Financial Advisor magazine, Boston Consulting Group, and 3ethos that attempts to benchmark how well advisors currently execute fiduciary best practices (the answer is not as well as we might have hoped and expected), and a disturbing investigation from the SEC into financial advisor and radio personality Ray Lucia that digs deeply into the backtesting models that Lucia used to support his strategies (raising the question about whether other advisors may also have made errors in assumption or process in their own in-house backtesting efforts regarding the strategies they recommend). From there, we look at a few more aspirational articles, including a vision from hiring consultant Caleb Brown about how financial planners may learn their craft in the future, an interview with practice management consultant Angie Herbers about how to develop great employees, and a great checklist for information you should be certain to cover on your website to give prospective clients what they want/need. There's also a nice technical summary of some of the planning implications of the Affordable Care Act in the coming years, some thoughts about where the ETF/ETN industry is heading (notwithstanding the growth, it might still be in the early stages!), and a good explanation and comparison of two different types of P/E ratios and what they tell us about whether stocks are cheap or not. We wrap up with some intriguing new research from Morningstar, suggesting that it's a myth that investors are dumb and pick bad funds; instead, the Morningstar research suggests investors tend to be pretty good at selecting high quality funds, but have a problem in timing the purchase of those funds poorly. Enjoy the reading!

Weekend reading for September 8th/9th:

Surprise! Fiduciary Advocate Calls FINRA Best Hope For Progress - In a surprise announcement this week, Barbara Roper, Director of Investor Protection at the Consumer Federation of America, stated at an event hosted by the Institute for the Fiduciary Standard that given how the SEC has been dragging its feet on fiduciary rulemaking - it still has yet to even put out a request for data for a cost-benefit analysis that would be necessary for rulemaking - that the best path to better investment advice standards may be for FINRA to step up and fill the role, noting FINRA's recent revisions to its suitability rules as a sign of progress. Roper also spoke positively of the SIFMA fiduciary roadmap proposal, although Institute president Knut Rostad stated that the SIFMA standard is a sales/broker standard, not a true fiduciary standard. Notably, the Institute will be meeting with SEC chair Mary Schapiro later in September, which the Institute has declared "Fiduciary September" in an effort to create momentum on the fiduciary issue.

Why Doesn't the RIA Community Come Up With Better Proposals? - In his monthly article for Financial Planning magazine, industry guru Bob Veres raises the interesting question of whether our regulatory debate is too stuck in the minutiae of how we're regulated, and whether we all need to step back and look at the bigger picture of how absurdly (at least in some ways) we're regulated in the first place, especially since in theory the point of the Dodd-Frank changes were to address reckless investment recommendations (like junk mortgage bonds) but somehow has ended out focusing on increasing exams of investment advisors when exams didn't catch frauds like Madoff and Stanford in the first place. Veres' conclusion to this is to suggest that perhaps RIAs need to do a better job of proposing their own solutions about how to be better regulated and better protect consumers from the bad apples, based on the realities of how RIAs are operated, and work more proactively with the SEC as an ally against the Madoffs still in hiding. 

Not Making The Grade - This cover article for Financial Advisor magazine explores recent research by the magazine, Boston Research Group, and 3ethos, study whether financial advisors are actually living up to the fiduciary duties they already have and following fiduciary best practices. The results are not entirely encouraging; the average score across the industry (including those obligated to a fiduciary standard and not) was a 76 (out of 100), representing a "C" grade. SEC-registered RIAs scored higher than stated registered RIAs, at 83 versus 79 respectively (in part because the latter firms are typically larger and have more systems and processes in place, as follow-up research details confirmed fiduciary practices were best amongst the largest firms). Dual-registered RIAs only scored a 75, while registered representatives scored a 66. When examined by the firm's categorical types, those firms that described themselves as wealth managers scored an 80, while retirement advisors scored 76 and financial planners scored 72 (albeit with no distinction between CFP planners and others who simply use the label). Don Trone, fiduciary expert and the leader of 3ethos that co-sponsored the study, suggests that the research may become an effective benchmark in the long run, as future fiduciary regulations that are promulgated by the SEC can be measured for effectiveness to see if they actually improve fiduciary best practices. 

SEC Charges Radio Personality for Conducting Misleading Investment Seminars - This press release from the SEC (reposted on various news sites) discusses an investigation into financial advisor and radio personality Ray Lucia, who advocates a bucket strategy for investing. What's notable about the charges is the particular details of the SEC's allegations, which essentially are that Lucia claimed the strategy had been backtested but that he had not performed the backtest properly. For instance, the allegations suggested that Lucia's use of a 3% inflation rate was inappropriate, as some of the time periods over which he tested had higher inflation. He also did not incorporate advisory fees into his backtesting. The incident raises some questions about whether the SEC may be getting more aggressive in the kinds of projections that financial advisors use, especially regarding the backtesting of various strategies that are recommended to clients. 

Is This the Financial Planner of the Future? - This article by recruiting/hiring consultant (and career development advocate) Caleb Brown describes a vision of how young people will enter the financial planning profession 20 years in the future. Major changes envisioned by Brown in the future include: a wide array of colleges offering financial planning programs, with introductory coursework starting freshman year; an on-campus counseling clinic to provide some practical experience; junior year summer internships through an organized national program with a subsequent internship in the 5th year of education; a 150-hour coursework (i.e., a Master's degree) requirement to sit for the CFP exam; and an exam that focuses more on applied financial planner knowledge (difficult to pass without some internship, clinic, and/or other experience). Brown notes that the seeds of many of these changes have already been planted, while a few still have a longer ways to go. 

Angie Herbers on Creating Great Employees and Solving the Fee Issue - In this "10 Questions" interview with the Journal of Financial Planning, practice management consultant Angie Herbers shares her thoughts on everything from her latest research on how to build an effective financial planning firm, to optimal business models and compensation methods. Highlights include a discussion of Herbers' "P4" principals for developing great employees: preparation, pay, perks, and productivity; why it can be counterproductive to have a lot of rules for your employees; that it's not about paying employees well but paying them fairly; that it's better to get someone with basic professional traits and train them to be great rather than trying to hire a star employee; and that combined fee structures (AUM plus a flat planning fee) can actually be very problematic.

Advisors, 4 Surprising Things Prospects Want to Learn When They Visit your Website - This article by business coach Suzanne Muusers provides a nice summary of what your website should convey to help clients decide whether they will work with you. The four keys: Do you have the expertise to help me?; Do you look like a "good" (i.e., trustworthy) person?; How much do I need to have [in investable assets] to work with you?; and How much is this going to cost me? In practice, many (most?) financial advisor websites fail on some or all of these points; in some cases, because the advisor is trying to retain (too much?) control over the relationship, and in others due to simple oversight. Consider this article as a good basic checklist for your own site to affirm that it's truly client friendly in telling them what they want/need to know!

Financial Planning Under The Affordable Care Act - This column from the Journal of Financial Planning highlights short- and intermediate-term planning implications of the Affordable Care Act, especially given that it has now been upheld by the Supreme Court. In the near term, the authors suggest that not much will change, as health insurance has been and remains important; if anything, the looming penalty for failing to buy coverage beginning in 2014 may be an incentive for more clients to implement the insurance recommendations their advisors have been providing (which will be even more appealing when in 2014 companies can no longer deny coverage or exclude benefits for pre-existing conditions). On the other hand, some fear that the expanded coverage requirements will cause premiums to rise, and either way more affluent clients will face two new Medicare taxes beginning in 2013 (one on earned income, and the other on unearned income). Business owners must also watch out, to be certain they comply with the new coverage requirements for employees that become effective in 2014. Overall, this article provides a great summary of the wide range of new technical rules that are coming.  

Contemplating Capacity: Where Do We Go From Here? - This article is about exchanged-traded products (including ETFs and ETNs), and industry that has exploded in the past 20 years from zero to $1.2 trillion in assets. Given the strength of the trend already, how much room is left for more growth from here, and where will the innovation occur? Early on, the growth was in equity ETFs, but more recently the trend has shifted to fixed income solutions (as well as commodities), and only four of the ten largest exchange-traded products (ETPs) are equities-based at this point. Given a limit in how many asset classes remain to package into ETPs, the author suggests that the next wave will be finer tuned slices within existing asset classes, such as the increase in dividend-based ETFs as another way to slice equities, or new commodity-based ETPs that try to minimize the problematic drag of rolling futures contracts. The author also suggests that the ETP market will benefit from the ongoing trend towards fee-based advisors over commissioned-advisors (who seem to generally prefer the transparency and flexibility of ETPs), and that regulatory changes, while unpredictable, have recently tilted in favor of transparency and lower fees, which are both areas where ETPs tend to excel; the potential for wider adoption of ETPs in 401(k) plans also provides a significant avenue for growth. The bottom line - not only are ETPs not a fad but a substantive trend, but there's a possibility that the industry is still in the earlier stages for ETP growth.

Is The Stock Market Cheap? - This article by Doug Short of Advisor Perspectives highlights market valuation and whether stocks are "cheap" using two popular valuation measures - the Trailing Twelve-Month (TTM) P/E ratio (which divides the past 12 months of earnings into the current market price) at 15.9, and the P/E10 ratio (which takes an average of the past 10 years of earnings and divides into the current market price) at 21.5. Short observes that in practice, the TTM P/E ratio is often a poor indicator of value - since earnings often fall even more sharply than the market in a recession, often the market valuation AFTER a decline is higher than before, peaking as high as 123.7 after the 2008-2009 financial crisis. By contrast, the P/E10 ratio tends to be more stable and predictive of market returns. When viewed relative to history, the current P/E10 ratio of 21.5 puts the market in the top quintile of valuation (approximately the 83rd percentile), suggesting that the market is somewhat overvalued. However, given that P/E10 valuations tend not to bounce once they reach the average, and instead tend to revert all the way to the lows before starting a new bull market cycle, Short suggests a cautious perspective on investing.

The Myth Of The Dumb Fund Investor - This article from Morningstar Advisor takes an intriguing look at some of the Morningstar data and research to cast a new perspective on how investors choose funds. As the "myth" goes, most investors are bad at selecting funds, and should therefore just hold index funds and avoid their poor active fund choices. Yet what Morningstar finds when it digs into the numbers is that in reality, fund investors are actually good at selecting funds, when evaluated based on a comparison of asset-weighted to equal-weighted returns, often selecting funds with higher ratings, lower expenses, and more stable and investor-oriented funds (although the results were better for stock than bond funds). This in turn suggests the benefits of holding index funds may be overstated; while index funds do outperform the "typical" active funds, the Morningstar data suggests that proactive investors don't hold the typical funds. However, the results suggest that while investors tend to select good funds, they tend to time their allocations poorly. Thus, while from year to year investors tend to pick good funds, cumulatively over the past decade investors have tended to pick good funds at bad times. The implication of the article then is that while seeking out best-in-category funds may not actually be detrimental to investors, chasing category winners almost certainly is. 

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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