Enjoy the current installment of “weekend reading for financial planners” – this week’s reading kicks off with some of the latest industry news, including a new filing from the CFP Board in its lawsuit with the Camardas asking the court to either throw out the lawsuit or at least narrow the scope of the Camardas’ information requests as being a “fishing expedition” (if the court declines the motion, depositions of key CFP Board staff members will begin in the coming weeks); there’s also an interesting announcement from Schwab that they will begin rebating the last quarter’s worth of fees for any unhappy advisory clients (will other financial advisors feel compelled to match the offer for their own clientele?), and an interesting study from TIAA-CREF suggesting that Gen Y may actually be even more receptive to financial advice and willing to change their behavior than baby boomers.
From there, we have a number of “trends and predictions” articles that are so common towards the end of the year, including a white paper about “transformations” that broker-dealers must make to survive and be competitive as the differences between B/Ds and RIAs continue to blur with the movement towards AUM business models, a look at some of the big regulatory changes coming in 2014 (beyond just fiduciary and harmonization, look for increased focus on protecting clients from identity theft and business continuity plans for advisory firms), some of the biggest tech trends coming for advisors (big focus on the cloud and software integrations), and a broader look at four 4 trends that will impact advisors for many years to come (from demographics to technology and more).
We also have a few more technical articles this week, including a discussion from actuary Joe Tomlinson on some of the latest research debates on the best asset location strategies, an interesting (and high quality) analysis of some of the flaws in the Shiller P/E10 ratio and how to fix them, and a broad look at how estate planning is changing in a world of ‘permanent’ exemptions that have removed most clients from the reach of Federal estate taxes (shifting the focus to income tax planning, step-up in basis opportunities, and asset protection).
We wrap up with three interesting articles: the first discusses the recent acquisition of David Loeper’s Wealthcare Capital and their Financeware financial planning software by a private equity firm, which is notable not just because they are investing into growing the company, but because they may also try to re-assert Loeper’s patents related to financial planning (which some have gone so far as to call a risk to all financial advisors); the second is an article looking at the challenges that average Americans have with trying to save, and how it may be less a matter of their attention span or focus and more than the sheer urgency of spending interruptions prevents them from ever focusing on the less-urgent-but-still-important financial goals; and the last is an interview with indexing legend John Bogle, who suggests that the ETF industry has taken indexing “too far” and that he wouldn’t advocate investing in almost 97% of today’s ETFs! Enjoy the reading!
Weekend reading for December 21st/22nd:
CFP Board Seeks to Quash ‘Annoyance,’ ‘Expense’ of Lawsuit – In the latest action of the Camarda vs CFP Board lawsuit, the CFP Board has filed a motion asking the DC courts to either throw out the Camarda lawsuit entirely (on the grounds that it’s a disciplinary decision of a private organization with voluntary membership and is not something that should be subject to judicial review), or alternatively asks the court to decline the Camarda request for transcripts and details pertaining to any/all other CFP Board disciplinary commission incidents pertaining to compensation (declaring that only the transcript of the Camarda hearing and appeal itself are relevant and that the rest is a “fishing expedition”). Yet Tina Florence, a former DEC member (who has also received a private sanction for compensation-disclosure-related issues) suggests that similar cases of CFP certificants should be a part of the process, as they are precedents that the CFP Board does cite in subsequent disciplinary matters. It remains to be seen whether the courts will accept the CFP Board’s motion; if not, in the coming weeks depositions are scheduled for CFP Board CEO Kevin Keller, its head of disciplinary and legal affairs Michael Shaw, board counsel Adam Zajac, and more, including several former CFP Board disciplinary panel members.
Schwab Offers Fee Rebate To Unhappy Advisory Clients – Last week, Schwab announced that “if, for any reason, clients are unhappy” with their fee-based investment advisory programs, Schwab will rebate the last quarterly fee that the client paid. As Schwab views it, the change is intended to continue shifting its image from being a cheap do-it-yourself platform to a more full-service firm and complements its shift towards charging ongoing AUM fees, while providing a level of accountability for clients. On the other hand, showing confidence in its own offering (and confidence that clients will not try to game the system), Schwab notes that it has not set aside a large number for fee rebates and doesn’t expect the offer to be utilized very often. From the broader industry perspective, the question is raised about whether Schwab’s move is just hype and an aberration, is opening up a “can of worms”, or is setting the precedent for a new industry standard where advisors may feel compelled to also offer rebate-of-last-quarterly-fee offers for unhappy clients. The pressure may be on, though, as Schwab has announced that they intend to broadly advertise the program nationally.
Gen Y Most Receptive to Financial Advice – TIAA-CREF recently surveyed 1,000 young adults aged 18 to 34 (known as the “Millennials” or Gen Y) about their financial habits, and the results are intriguing. 71% of the young adults were more likely to monitor savings after getting financial advice, and 66% were more likely to change their spending habits; these change rates were larger than older cohorts, suggesting that Gen Y may be more recently to financial advice. However, the ways that Gen Y wants to engage are different; 61% were interested in interacting with an advisor online, 59% wanted to attend webinars, and 58% wanted live seminars (compared to only 45%, 475%, and 46% respectively for overall Americans, according to the survey). In addition, 76% of Gen Y stated they want financial advice specifically designed for their needs – not just generic content and education – and 72% wanted relevant tools and calculators that break down complex advice principles. Given what is perhaps their perceived lack of tools and available advisors dedicated to them, though, 70% of the Gen Y advice seekers indicated they rely on friends and family for financial advice, while older-than-34 participants relied primarily on financial service provider websites or online tools.
6 Critical Transformations BDs Must Make – This article highlights the recent “Broker-Dealer of the Future II” study by Pershing which looks at how the broker-dealer environment will shift significantly in the coming years. The key issue is the migration of broker-dealers towards AUM and fee-based advisory accounts; as advisory fees become the number one source of revenue for broker-dealers, and more and more advisors function in as independent fee-only advisors, the world of broker-dealers and RIAs converges, which is a significant threat given the larger organizational structure and overhead of most broker-dealers. So what can broker-dealers do if they want to survive? The six key “transformations” recommended by the study are: 1) identify ways the broker-dealer can avoid ‘commoditization’ (what’s the value-add); 2) foster organic growth of existing relationships (help your advisors grow themselves); 3) establish a sound economic model (manage the overhead); 4) avoid the winner’s curse of high-cost recruitment; 5) espouse advisory services; and 6) demonstrate stability and longevity. The study delves deeper into the commoditization issue in particular, emphasizing that the key for broker-dealers will be to know their niche and what they’re best at, and focus relentlessly on it; right now, 87% of advisors state that their broker-dealers are “less than very effective” at communicating the value of their offerings (a marketing trap that advisors struggle with themselves, too!).
5 Big Regulatory Changes Coming in 2014 – Compliance consultant Nancy Lininger makes some predictions about the big regulatory issues and changes looming for 2014. Certainly, the biggest is the potential for a new fiduciary standard, with prospective rules coming from both the Department of Labor and the SEC next year; in addition, potential harmonization of brokerage and advisory rules may also be coming in conjunction with the SEC’s fiduciary efforts. Beyond the fiduciary/harmonization issues, though, Lininger also notes a growing concern from state securities regulators that FINRA’s arbitration framework for brokers is no longer appropriate, and the North American Securities Administrators Association (NASAA) is strongly supporting the Investor Choice Act of 2013, which (if passed) would prohibit the use of mandatory pre-dispute arbitration agreements by broker-dealers or RIAs (notably, Dodd-Frank legislation also authorized the SEC to take up the issue of arbitration, though it has not acted at this point). Other areas of focus that may be looming in 2014 is heightened scrutiny around Business Continuity Plans (BCPs), as the SEC, CFTC, and FINRA recently issued a joint advisory to suggest effective practices, and the SEC separately issued a risk alert for investment advisors on the issue. The last area of regulatory focus for 2014 is around identity theft, as the rising volume of wire fraud attempts and other identity theft schemes against clients of advisors and their investments is bringing a new level of scrutiny to the issue, and putting pressure on advisory firms to better articulate clear processes and “red flags” that they will use to detect and thwart identity theft and fraud against their clients.
6 Biggest Tech Trends for 2014 – Drawing on Financial Planning magazine’s recent 2013 Advisor Tech Survey (covered in Weekend Reading two weeks ago), this article by industry consultant Joel Bruckenstein looks at the 6 biggest tech trends for advisors in the coming year. The key areas are: 1) continued cloud migration (especially for smaller firms the outsourcing brings both efficiency and potential cost savings over internal staffing) that gets more and more compelling as the breadth of solutions grows; 2) better, deeper integrations (hampered by a lack of data standards, but continuing forward nonetheless); 3) heavy investment by broker-dealers and custodians in technology; 4) persisting security concerns (while security solutions improve, shady characters are also increasingly targeting advisors and their clients, looking for weak points); 5) data power as advisors finally begin to get tools to harness the information and data about their clients; and 6) better client experience as competition from online tools like Mint and Personal Capital pressure advisors to implement more and better technology solutions to support their clients.
4 Big Trends You Can’t Ignore – In this feature article in Investment Advisor magazine by editor Jamie Green, the focus is not just on near-term trends for 2014, but broader trends impacting the financial advisory world and how they may play out in the coming years. The first big issue is the demographics of advisors themselves; the country may be getting more diverse, but advisors, not so much, as the typical advisor is still a white male in their 50s or 60s, and overall the industry average age for advisors is 54 (rising almost a full year for every year that goes by), with only 22% of advisors under 40 and 5% under 30 and a percentage of females that has remained stubbornly around 15% for a while now. And the typical clients of advisors remain primarily the baby boomer peers of the advisors themselves. Green suggests that these demographic trends will push an ongoing focus on succession planning, an eventual shift towards differentiated marketing (with ‘boomer-centric’ firms contrasted from younger-generation focused offering), and new marketing approaches (e.g., social media) to reach the different/new generation. Another key trend is regulation, with looming fiduciary rules of some sort or another from both the Department of Labor and the SEC, with not only obvious direct regulatory impacts, but also indirect ones like greater interest in fiduciary training from companies like fi360 and educational programs like the CFP certification. The third big trend is technology, including a prediction that eventually there will be more “RateMyAdvisor” services (notwithstanding the apparent regulatory testimonials-rule challenges), an acknowledgement that robo-advisors are beginning to impact the landscape (though whether they are competition or prospective partners remains to be seen), and a general recognition that things like a good digital presence (e.g., a quality website) are quickly becoming a minimum standard. The last trend area is what Green calls CCVC, which stands for Choice, Consolidation, Volatility, and Clients – a recognition that advisors have more choices than ever, even as they try to consolidate to achieve scale, managing a more volatile environment, and becoming more focused on customized and personal solutions for clients (as technology allows us to make the client experience more personal than ever).
Optimizing Asset Location: Is It Worth The Effort? – This article by Joe Tomlinson on Advisor Perspectives dives into some of the research on the choice about whether to hold stocks in taxable accounts and bonds in tax-sheltered accounts, or vice versa, also known as the “asset location”decision. On the one end are articles by those like yours-truly, who has written about asset location decisions by evaluating which locations provide the greatest future after-tax wealth, and suggested that in a low-return environment, it doesn’t necessarily pay to force bonds into a tax-sheltered account, especially if it means replacing tax-inefficient higher-returning equities or other alternatives. The alternative approach, espoused most clearly by Reichenstein and Meyer in a recent Journal of Financial Planning article (also previously highlighted in Weekend Reading), which notes that because the Federal government shares in the gains and the losses of brokerage accounts (the latter in the form of capital loss deductions), that it’s superior to hold equities in brokerage accounts because the after-tax risk is diminished (since the government is sharing the exposure). Accordingly, Reichenstein/Meyer argue that the investor’s standard deviation for equities held in brokerage accounts is different than that for equities held in tax-sheltered accounts, and when Tomlinson applies a classic Modern Portfolio Theory mean-variance optimization, the differences in risk exposure tilt the portfolio in favor of placing equities in the brokerage account. Ultimately, Tomlinson agrees that with the Reichenstein/Meyer risk framework, locating equities in brokerage accounts may make sense, but questions whether the complexity of the calculations and analysis is worthwhile for what may be a relatively limited benefit of their methodology, especially given the low return environment where Tomlinson estimates the utility differences may be no more than 0.05%.
Fixing the Shiller CAPE: Accounting, Dividends, and the Permanently High Plateau – This article provides some interesting perspective on the Shiller Cyclically-Adjusted Price-Earnings ratio (or “CAPE” for short), a metric that has been increasingly popular as a measure of long-term valuation, even as the author notes that it may becoming less effective (at least without some “fixing”). The issue is that for most of its 130 year history, CAPE has revolved in sine-wave-like fashion around its long-term average of about 15.3 (spending 55% of the time above the average and 45% below)… except since 1990, when it’s been above the average 98% of the time, dipping below only briefly for a few months in the aftermath of the financial crisis. In other words, while CAPE seemed to consistently mean-revert in the past, it’s not clear if it still does so – which means either the measure may be “broken” altogether, or at least there may be a “new” mean towards which it is reverting. The point here is not just some argument around a “new normal”, per se, but an acknowledgement that while CAPE is based on “earnings” the accounting standards that define what constitutes earnings have not been consistent. Yes, CAPE earnings are based on “as reported” earnings under GAAP, but GAAP itself has changed; for instance, the accounting around “goodwill” in an acquisition was materially changed in 2001, such that companies could no longer amortize goodwill in purchases and must immediately write it down as an earnings loss when impaired (even though they don’t “write up” goodwill when an acquisition turns out well), and the end result is that there’s a significant and growing gap between historical and current earnings measures. While the new GAAP accounting rule around this may arguably be better for accounting purposes, it still means a potential apples-to-oranges comparison with the historical data. A similar problem emerges as companies change their dividend-vs-buyback policies; in essence, companies that buy back shares (instead of paying out dividends) reduce the number of outstanding shares, which results in a distortion when fewer current shares at current earnings pushes up EPS and therefore prices, yet when prices are compared to historical earnings they now appear ‘artificially’ elevated. And again, the behavior of companies with respect to their dividends has been inconsistent; from 1954 to 1995 the average S&P 500 dividend payout ratio averaged 52%, while since 1995 it’s been only 34%, and is reflected in the growth of EPS over those time horizons (1.72% vs 4.9% respectively), which means again CAPE may not be as far “out of whack” as some suggest. The end result of all these changes is that while an “adjusted” CAPE might still show the market is overvalued, it may only be modestly overvalued, not the scary overvaluation implied by the headline CAPE numbers. And of course, that assumes that CAPE will ultimately mean revert at all, and that it’s not stuck at a “permanently high plateau” new normal (at least until some novel catastrophe befalls the economy!). (For a quick response to some of these CAPE criticisms, see this post by Meb Faber as well!)
Big Ideas in Estate Planning Now – This article from estate planning expert Marty Shenkman in Financial Planning magazine looks at some of the top ideas in estate planning (based on a survey of presenters for the upcoming Heckerling Institute on Estate Planning), now that we’re about a year out from the big changes enacted by the American Taxpayer Relief Act, which made permanent the higher exemption levels and portability of the estate tax exemption. One key issue on the minds of presenters are the subtle challenges involved with effective planning for portability of the estate tax exemption; the traditional estate plan was built on a bypass trust and marital trust, but with permanent portability surviving spouses can get the first-to-die spouse’s exemption without the use of trusts. Relying on portability does have challenges – including no portability for state estate taxes or generation-skipping transfer taxes, nor any asset protection – but using bypass trusts also have challenges, including the loss of a step-up in basis on bypass trust assets when the second spouse passes away. In fact, Shenkman notes that for many, estate planning may be increasingly focused on taking advantage of step-up in basis opportunities, especially for those with estate tax exposure; thus, the goal suddenly becomes how to include assets in the estate (to get a step-up in basis), rather than to exclude them (to avoid estate tax exposure). An increasingly popular approach is the creative granting of general powers of appointment (which grant the person a right to designed where assets can be distributed, including potentially to themselves, their estates, or creditors) to those who have excess estate exclusion amounts, to “absorb” the exclusion and attach a step-up in basis to the associated property. In other situations, people may try to swap assets to take advantage of the rules, between themselves and their partnerships or perhaps themselves and their grantor trusts. Beyond income and estate taxes, Shenkman notes an increased focus on asset protection (especially for those with no estate tax exposure), by using trusts for asset protection purposes or even “decanting” strategies that pour the assets of old (not-asset-protected) trusts into new (more-robustly-protected) trusts. A final area of estate planning are income-shifting strategies within the family to try to navigate the new Medicare taxes on earned income and investment income, such as drawing business income via S corporation dividends to owners who actively participate in the business.
Private-Equity Firm Buys The Loeper-Wealthcare Financial Planning Patent – A private equity firm called NewSpring Holdings has bought Wealthcare Capital Management, the company founded by David Loeper that offers the Financeware financial planning and Monte Carlo software (along with being a financial planning and investment management firm itself). The new private equity firm is bringing in a series of notable executives to support the growth of the company – including industry legend and Lockwood CEO Len Reinhart, the former founder and CEO of Healthaxis (the first digital insurance agency that has since gone public in an IPO), and the marketer who led the team that developed the E*Trade baby commercials. But perhaps the real value of Wealthcare is that Loeper had previously obtained a patent on his software process of linking personal financial goals to investments – a patent that has been enforced once already against MoneyGuidePro via its enterprise client UBS, which was settled last year. This patent is also the notable threat tied to the Wealthcare acquisition – when the lawsuit against UBS and MGP occurred in 2011, it was dubbed “a risk to all financial planners… [that] is anyone does a plan then Dave Loeper is going to get a royalty” and whether “if certain aspects of the Wealthcare patent [are] upheld, or construed broadly, [whether] all financial planners using goals-centric approaches to their clients would be required to pay Wealthcare royalties.” While Loeper has objected in the past to such characterizations – he notes that in the past 14 years, the MGP/UBS lawsuit was the only one he ever filed – he also he refused to rule out the possibility of further industry litigation, and similarly the new Wealthcare executive agrees that Wealthcare will fight companies that use its process without paying, even while claiming that the company is not on a witch-hunt (and with private equity firm backing, may now have deeper pockets to pursue these issues more aggressively). For the time being, though, the focus of the new Wealthcare seems to be oriented towards better marketing and growing the firm organically, but the potential remains looming that patent lawsuits around the processes of financial planning may emerge again under the new ownership.
Why Some People Can’t Save: A Matter of Urgency – This article from personal finance blog Consumerism Commentary takes an interesting look at the concept of urgency, and how it shapes our (financial and other) decisions and priorities. The greatest conflicts occur when matters arise that are urgent but not necessarily important, yet we have difficulty ignoring them; in the employment context, that might be the boss who says he needs a special accounting report on a trivial matter (but urgent to him and he’s the boss) that disrupts your work on a genuinely important upcoming financial report to be released to investors. If you are interrupted too often in trying to deal with these sorts of urgent-but-not-really-important requests, at best it will disrupt your ability to do the also-urgent-and-genuinely-important tasks, and will virtually guarantee you never get around to the important but not urgent issues. In fact, priorities can basically be placed into a 2×2 grid, where they are either low importance and low urgency (distractions), high importance and low urgency (long-term key goals), high importance and high urgency (critical activities), or low importance but high urgency (interruptions). Accordingly, the article breaks most common household expenditures into the four quadrants (see image, right), and the challenges of most consumers quickly become clear; matters like hospital bills, home (or auto) repairs, etc., are looming interruptions that prevent people from ever getting to some of the non-urgent important goals like saving for children’s educations or retirement. The more limited the household funds, the more the household’s decisions are dictated by urgency alone, as the importance dimension becomes irrelevant to the process – but the key is that the issue may be less about a lack of self control or attention, and simply that the sheer size and cost of the interruptions is so overwhelming for the household budget that there’s simply nothing left to allocate to the long-term importance goals. Instead, the real focus must be on making the size of the pie bigger in the first place – i.e., how to increase human capital and earn more income – or how to reduce the exposure to interruptions in the first place so that focus can shift to matters of importance.
Vanguard’s Bogle: Indexing Has Gone ‘Too Far’ – In this fascinating Financial Planning magazine interview with John Bogle, the Vanguard founder and indexing legend suggests that the proliferation of index ETFs has gone “too far” and that too many of today’s “index” funds are now so concentrated, leveraged, or otherwise risky that they should be avoided. From commodity ETFs that have a negative drag due to contango to overly specialized ETFs like the “Emerging Cancer ETF” (which Bogle criticized in a Wall Street Journal op-ed, and is no longer in business), Bogle states that “1,450 out of 1,500 ETF funds [he] wouldn’t touch because they’re not diversified enough.” Accordingly, Bogle differentiates from what he calls “TIFs” (traditional index funds) made to be bought and held, versus so many of today’s index ETF that are “traded like a fury.” Bogle also cautions against alternatives, stating that he thinks “most of them are silly… [and] faddish” as alternatives only seem to come up as a “diversifier” when they’ve done well recently, even though most of them have no real internal rate of return and are ultimately just speculations on price (as there are no future cash flows from gold to support future prices the way there are for stocks and bonds). Bogle also notes that even real estate, which does have internal cash flows to support value, is different (and less of a diversifier) in securitized form than it is with direct investment. In addition, Bogle observes the overall changing landscape as well; when he started, institutions owned only 8% of all stocks, but now it’s closer to 70%, which leaves a lot less room for individual investors to “outsmart” the “smart” institutional money.
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, including his “FPPad Bits And Bytes” weekly advisor technology update!
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!