Enjoy the current installment of “Weekend Reading for Financial Planners” – this week’s edition kicks off with the news that industry giant Envestnet has filed with the SEC to launch its first four ETFs, which will take an ‘ActivePassive’ approach that will take both active and passive investing approaches within the same ETF. And while Envestnet has previously used the ‘core and explore’ approach in its mutual funds, these will be their first offerings using the more tax-friendly ETF wrapper.
Also in industry news this week:
- Client risk assessment provider Riskalyze is further expanding its product offering with ‘Discovery’, a tool that combines Riskalyze’s risk assessment score with its proprietary investment risk-adjusted performance metrics to facilitate client portfolio construction for advisors
- A new company is being formed that will support RIAs that want to provide Pooled Employer Plan (PEP) services to clients without running afoul of IRS rules
From there, we also have several articles on retirement planning, including:
- A critique of Morningstar’s suggestion that the “4% Rule” for safe retirement withdrawal rates should be lowered to 3.3%, from the financial planner who first wrote about the 4% Rule
- New research shows how retirees increased their spending as a percentage of their pre-retirement income from 2016 to 2019… but subsequently cut back when COVID struck in 2020
- How the new, streamlined Social Security statement better illustrates the potential benefits of delayed filing
We also have a number of articles on year-end tax planning:
- How to reduce the capital gains tax impact from rebalancing investment portfolios after a strong year of performance in the stock market
- How to determine which types of assets (and accounts) make for the most tax-efficient charitable contributions
- Why cryptocurrency investors may see increased scrutiny from the IRS as it ramps up its efforts to enforce tax compliance on digital assets
We wrap up with three final articles, all about charting a career path and how it might change along the way:
- Why mental models can be useful tools for individuals considering a career change
- How individuals can facilitate ‘hot streaks’ in their career by exploring different areas and exploiting their skills once a promising opportunity is identified
- The importance of understanding which ‘career season’ – growth, lifestyle, and reinvention – an individual wants to pursue at a given time
Enjoy the ‘light’ reading!
Envestnet Files To Launch Its First Four ETFs And Invents A Category (Brooke Southall, RIABiz) - Financial advisors who use Exchange-Traded Funds (ETFs) when constructing client portfolios have a wide range of choices that have traditionally been grouped into ‘active’ funds (where the portfolio manager has discretion to invest according to the theme of the ETF), and ‘passive’ funds that track the holdings of a selected index. And while some mutual funds have a ‘core and explore’ approach that includes both active and passive components, this strategy has so far not been available under the tax-friendly ETF wrapper. And so, industry giant Envestnet has filed with the SEC to launch four ETFs that combine active and passive strategies and include US Equity, International Equity, Core Bond, and Intermediate Municipal Bond ETFs. For Envestnet – whose asset management business already includes $20 billion under management or advisement in models, direct indexing separately managed accounts, and open-end mutual funds – the ETFs will expand their in-house fund offerings. And while the exact details of fees and how each fund will be invested have yet to be released, the ETFs will provide a one-fund option for advisors looking to invest client assets in both active and passive strategies in a given asset class with the tax benefits of ETFs (which might be on the minds of advisors at this time of year when many mutual funds make capital gains distributions!). And although some advisors might continue to shun active ETF funds, the new offerings could be a way for advisors to dip their toes into active management while maintaining a ‘core’ passive approach. So while debates about the benefits of active and passive investment strategies will no doubt continue, the proposed Envestnet ETFs could provide a way for agnostic advisors to split the difference in a single product!
Riskalyze Broadens Its Product Set With ‘Discovery’ (Samuel Steinberger, Wealth Management) - Client risk tolerance assessments have significant advantages compared to advisor-client conversations about risk and have become an important part of a financial advisor’s toolkit. To meet this demand, the number of firms operating in the client risk tolerance space has been growing, with 13 companies now appearing on the Kitces Financial Advisor FinTech Solutions Map. And while this competition is good for advisors looking to find the most appropriate and best-priced solution for their needs, it creates a need for each of these companies to differentiate their products in the minds of advisors. Perhaps responding to competition from larger advisor technology providers like Orion and Morningstar, risk tolerance assessment provider Riskalyze has further expanded its offerings with an investment analysis tool dubbed “Discovery”. The tool combines a client’s ‘Risk Number’ generated from Riskalyze’s risk assessment platform with Riskalyze’s ‘GPA’ risk-adjusted performance score for investments to match clients with investments and facilitate the portfolio construction process for advisors. The new tool is the latest addition to Riskalyze’s offerings, which also include trading automation, marketing support, and integrations with other advisor technology tools. While Riskalyze previously engaged in a campaign criticizing the risk assessment methodology of its competition, the recent upgrades to its features (following a capital infusion earlier this year) suggest that the company will seek to offer a more comprehensive product that can compete with the offerings of the larger players.
New Firm Sees Opportunity In PEPs As ‘Operational Fiduciary’ (Emile Hallez, InvestmentNews) - Small business owners have long faced cost and administrative challenges in offering workplace retirement plans to their employees. To reduce this burden, employers, for decades, had the option to join a Multiple Employer Plan (MEP), which allowed multiple employers to pool together and create one single plan for their employees. However, MEPs only had limited popularity because of limitations imposed by the Department of Labor (which required MEP participants to be in the same general line of business) and the IRS (which disqualified an entire MEP if one participant failed to follow plan requirements) that made maintaining an MEP difficult. To ease this burden, the December 2019 SECURE Act created a new “Pooled Employer Plan” (PEP) that removed the ‘same line of business’ requirement and created a pathway to remove an employer that fails to comply with the plan’s rules. In order to create and offer a PEP, the plan provider must become a designated “Pooled Plan Provider,” (PPP) registered with the Department of Labor and serving in a fiduciary capacity. And while RIAs are allowed to serve as PPPs and could consider offering it as a service to clients who own small businesses, the potential to create a Prohibited Transaction in the course of offering investment services to the plan (and receiving compensation from the plan in connection with transactions involving the income or assets of the plan) makes this opportunity less appealing. With this in mind, a new company, Group Plan Systems, will serve as a PPP for RIAs, broker-dealers, and banks that want to offer PEP services to clients. And with a growing number of states mandating retirement plan coverage, RIAs could see increasing interest from clients with small businesses in PEPs and the new company could provide a way for advisors to manage plan assets while reducing the risk of running afoul of the IRS!
Is The "4% Rule" Now The "3.3% Rule"? (William Bengen, Advisor Perspectives) - In the October 1994 issue of Journal of Financial Planning, financial advisor William Bengen demonstrated that, based on a historical analysis of stock and bond returns, retirees could withdraw up to 4% of their portfolio’s value each year over a 30-year time horizon without fear of outliving their money. Though never universally agreed upon, the resulting “4% Rule” for safe withdrawal rates became a rule of thumb for many investors deciding on how much to spend during retirement. A new study by Morningstar challenges the 4% Rule, however; it asserts that low bond yields and high equity valuations will lead to lower future portfolio returns than those experienced in the past. As a result, the paper concludes, a conservative “safe” withdrawal rate would be only 3.3%. In Bengen’s response to the Morningstar paper, he ironically notes that he has recently increased his estimate of a safe withdrawal rate to 4.7%. Looking into the data used for Morningstar’s projections, Bengen points out two key assumptions that drive the lower withdrawal rate: first, the study assumes that asset returns will be much lower than they have been in the past (projecting a 5.23% return for a 50/50 portfolio, versus historical returns from 1926 to 2020 of 9.55%); and second, that this low-return environment would persist for (at least) a 50-year time horizon. As a result, while the Morningstar paper generated a lot of headlines for going against the conventional wisdom of the 4% rule, it did so using potentially unrealistic assumptions (since historically, no period of below-average returns has lasted anywhere near that length of time). This matters because while studies of “safe” withdrawal rates generally focus on the downside of running out of money in retirement, the “upside” risk of higher-than-expected returns means that retirees who decrease their withdrawal rates in response to the Morningstar study could have an even greater likelihood of having unspent wealth at the end of retirement (that could have been enjoyed earlier)!
Why Retirees Are Spending More Than They Used To (Jane Wollman Rusoff, ThinkAdvisor) - For decades, the conventional wisdom around retirement planning has been that a household’s spending needs after retirement are much less than they are while working; while a retiree’s lifestyle needs remain relatively stable, other types of expenses decrease. For example, retirees often pay less in taxes, don’t have dependent children to support, may have paid off the mortgage on their house, and of course, have no need to save for retirement once they are actively withdrawing from their portfolio. So it is often assumed that about 70%-80% of a household’s pre-retirement income will be sufficient to meet their spending needs after retirement. However, according to research recently published by JP Morgan (based on the activities of over 5 million Chase account holders), the percentage of pre-retirement income that households needed for spending during their first year of retirement rose from 80% in 2016 to 92% in 2019. Notably, the published research does not include the pandemic-altered year of 2020, in which spending by retirees decreased by 5%-9%... suggesting that perhaps the higher pre-COVID spending levels were a result of retirees’ increased ability to spend (enabled by higher portfolio values at the tail end of the post-2008 bull market), and that they shifted their behavior to become more conservative during the volatility and uncertainty of the COVID era. While it remains to be seen how retiree spending needs have changed in 2021, the data lends credence to the idea that many people can maintain a flexible budget in retirement, effectively cutting back to their “core” expenses in times of doubt, while boosting their discretionary spending in more confident times.
Check Your Redesigned Social Security Statement (Michelle Singletary, Washington Post) - Due to budget issues, the Social Security Administration (SSA) stopped mailing paper Social Security statements to most Americans in 2017 (after having stopped and restarted sending statements several times since 2011). As a result, many people who have not had the time or technical wherewithal to create a My Social Security account and log in to the agency’s website may not have seen their Social Security statement for several years. But now, SSA has redesigned their statement to be more streamlined and user-friendly, creating an excellent opportunity for those who have not yet signed up for an account to do so. The new statement replaces the old version’s large blocks of text with shorter, bullet-pointed summaries and halves the length from four pages down to two (which, at the cost of cutting out some information that was included on the previous statement, also reduces the likelihood that the most important information will be lost in the sea of text about topics like the Windfall Elimination Provision and Government Pension Offset that are less relevant for most people). Also of note is that the new statement presents estimated monthly retirement benefits in bar chart form, showing the monthly amount for starting benefits in each year from age 62 (when most people are eligible to start Social Security benefits) until age 70 (the maximum age to which they can delay filing to increase their benefits). The graphical element is a more powerful visual reminder of how each year of delaying increases the monthly payment and could lead more people to realize the potential benefits of delaying (if they actually log in to look at their statements!). For planners who help their clients to review their Social Security statements and optimize their benefits, the changes are a good opportunity to renew the conversation and guide clients through the process of logging in and reviewing the new statement.
Trimming Your Stocks Without Triggering The IRS (Jason Zweig, Wall Street Journal) - The end of the year is often a time for investors to check their portfolio allocations and rebalance to keep assets in line with their targets. And with the S&P 500 up over 20% year-to-date (even after the volatility of the past week), many portfolios’ stock allocations may have drifted higher than what is appropriate for those investors’ risk tolerance or time horizon, making rebalancing all the more important to restore the portfolio’s proper risk profile. In tax-deferred or Roth accounts, where capital gains are deferred until withdrawal (or entirely tax-free, in the case of Roth accounts), the investor doesn’t need to worry about triggering a capital gain when selling stocks or stock funds that have risen in value. But in taxable accounts, investors need to be more careful about how and when they sell to avoid incurring a large tax bill, and Zweig offers three possible strategies for reducing the tax impact of rebalancing. One method is to receive dividends and capital gains distributions from stock ETFs and mutual funds in cash rather than reinvesting them, then allocating the proceeds to bonds. (Although the tax savings with this strategy would be minimal, since dividends and capital gain distributions are already taxed when they are received, it would at least reduce the number of potential transactions and potentially save on trading costs). The second strategy is to look for other assets – such as bond funds, which are on average down 2% year-to-date – that could be sold at a loss to partially offset gains from selling stocks (though with the increase in stock prices so much higher than the decrease in bonds, it could be difficult to fully offset the capital gains). Finally, charitably minded investors can consider gifting appreciated shares of stocks or funds. The shares can go to a relative or friend, in which case any capital gain would be taxable to the recipient if they were to sell the shares. Or they can instead be donated to a charitable organization or donor-advised fund, in which case the donor may receive a tax deduction for the donation and avoid incurring a capital gain. Ultimately, while it’s obviously preferable to pay no more tax than is necessary, it’s worth keeping in mind that, unless the investor intends to give away most of their invested assets or leave them to their heirs, the taxes on investment growth will need to be paid sooner or later… meaning that, as long as selling doesn’t push the investor into a higher capital gains tax bracket, “avoiding” capital gains is really simply deferring them to a later date and may not be economically any different from just paying them now!
What’s The Most Tax-Efficient Way To Give? (Mike Piper, Oblivious Investor) - There are many good reasons to give to charity. Hopefully, the primary reason for most people is to support a cause that they care about; however, the tax incentives that the government offers for charitable donations create a way for giving to be financially advantageous for the donor as well. But in typical IRS fashion, there is not just one way to give to charity and receive a tax deduction: Instead, there are different tax treatments for different contributions, depending on the type of assets donated and what type of account they are held in. As a result, people who donate are often concerned about doing so in the most tax-efficient way possible… and for a typical retiree – who might have a traditional and Roth IRA, a taxable brokerage account, and cash available to make donations from – deciding how to give can be even more difficult than deciding where to give. Here, Piper gives a helpful framework for deciding which commonly owned types of assets to donate, and an order of preference for individuals over and under age 70.5 (the age when someone is eligible to make Qualified Charitable Distributions, which did not increase to 72 along with the age for RMDs!). In general, making a QCD from an IRA often has the greatest tax impact (and by reducing the donor’s Adjusted Gross Income, can have other benefits like reducing Medicare premiums and/or the taxable amount of Social Security benefits), while donating appreciated securities can have other advantages (particularly for those who are unable to make QCDs). On the other end of the spectrum, donating securities at a loss is usually the least efficient way to donate, as the investor would usually be better off first selling the security to capture a tax loss before donating the proceeds in cash.
The IRS Is Coming For Crypto Investors Who Haven’t Paid Their Taxes (Laura Saunders, Wall Street Journal) - The year 2021 has represented a turning point in the evolution of cryptocurrency from being a niche interest for hardcore enthusiasts to becoming a widely traded asset in many investors’ portfolios. At the beginning of the year, the total market cap of all cryptocurrencies had yet to cross $1 trillion; today, it stands at over $2.5 trillion. But with the increased interest in crypto as an investment asset comes more attention from the IRS, which has ramped up its efforts to enforce tax compliance on crypto traders. At the heart of the issue is that, unlike traditional brokerage firms, crypto exchanges are not required to report their customers’ transactions to the IRS, leaving it up to the investors themselves to report their own transactions and any resulting income from capital gains. This loophole could make cryptocurrency a potential avenue for fraud, tax evasion, and money laundering, so the IRS has increased pressure on crypto exchanges to turn over information about their customers. Earlier this year, the IRS issued court-ordered summons to several major crypto exchanges requiring them to hand over customer records. And in a criminal investigation annual report published in November, the agency announced that it had seized $3.5 billion worth of cryptocurrencies connected to a range of criminal activities during its 2021 fiscal year, and that it intends to continue that trend in the year ahead. For crypto investors, then, it will be more difficult to trade going forward while escaping the IRS’s notice… which means that understanding – and complying with – the tax rules surrounding crypto (which generally, but not always, mirror those for capital assets like stocks and bonds) can save investors from facing tax bills, penalties, and even criminal prosecution in the future.
Mental Models For Career Changes (Farnam Street) - The pandemic and its related changes to the home and work environment have led many individuals to contemplate changing careers. However, a career change can seem daunting and risky given the potential need to learn new skills, move to a new location, or take a pay cut. To help make better decisions regarding a potential career change, individuals can use mental models that can clarify the direction they want to go and plan for how to get there. An individual can first consider the ‘destination’ they want to reach in their career and then work backward to consider the steps that will be necessary to reach that career goal. For example, if an individual will have to take an initial pay cut until they work their way up the ladder in their new job, they will want to make sure they have the financial flexibility to cover their expenses with their reduced salary. After deciding on the destination and the path to get there, the individual can then take stock of their current skills and how they could apply to their new career. For example, they might have strong writing or speaking skills that they were not able to use in their current job, but could be valuable to a future employer. Next, the career-changer can create a comprehensive ‘map’ of their dream job by speaking with individuals in the field or at the specific organization (or listening to interviews with individuals who have made a similar career change!) to see what they like and don’t like about their position and to get an accurate picture of what an average day might look like. Once they have a good ‘map’, the individual can then apply probabilistic thinking to everything they have learned about themselves and their desired position to consider how likely it is that the career change will be a good decision. And for individuals who are considering a career change into financial planning (or transitioning from a broker-dealer to an RIA!), there are plenty of resources—from interviews with individuals who have made a similar career change to step-by-step guides on how to do it—to help construct their mental models and make a well-informed decision!
Hot Streaks In Your Career Don’t Happen By Accident (Derek Thompson, The Atlantic) - ‘Hot streaks’ are a much-discussed phenomenon in sports. Whether it’s a basketball player hitting multiple three-point shots in a row or a baseball player with a long hitting streak, sometimes players have a burst of dramatic success. Researchers have also looked at hot streaks in other fields, such as art and science, to see if there is a common factor that can lead someone to have a career hot streak. According to Northwestern University economist Dashun Wang, almost everyone will have a hot streak in their career, but typically only one or two. Wang and other researchers found that such streaks often happen when a person explores many different ideas at work, considers what would best fit their skills, and then exploits what they have learned. This ‘explore and exploit’ process demonstrates the value of exploring new concepts or different jobs (rather than just specializing in one certain skill or job function), but also the need to be able to focus on the best opportunity once it is identified. For financial advisors early in their career, this could mean taking positions at different types of firms to decide what kind of firm and job function fits them best. Mid-career advisors might explore different ways to have a broader impact on the world and then select the course that will be the most impactful. And for advisors thinking about starting their own firm, ‘exploring and exploiting’ could mean considering various ‘niches’ for their ideal client and then drilling deep into it once one is identified. The key point is that hot streaks are not limited to famous individuals, and that advisors can take advantage of the ‘explore and exploit’ technique to have multiple career hot streaks of their own!
Career Seasons: Choosing A Role Based On The Lifestyle You Want (Ramit Sethi, I Will Teach You To Be Rich) - No two career paths look the same, and that can be the result of each individual’s preferences. While some might be aiming for the best title or highest salary in their field, others might seek out the most interesting work for them, regardless of the esteem. Even for individuals who are targeting a certain career path, what they choose to do at a given time could change over the course of their working years. Sethi identifies three ‘career seasons’ that individuals have throughout their lives: ‘growth’, when individuals are willing to put in the time to learn, and strive to earn more and move up the career ladder; ‘lifestyle’, when priorities outside of work, such as family, take precedent; and ‘reinvention’, when a person wants to completely change their role, or even the industry in which they are working. The career seasons framework can be applied to the financial advisory industry as well, with individuals in the ‘growth’ season looking to master the skills of financial planning, while those in the ‘lifestyle’ season might be looking to scale back their responsibilities at their current firm or keep their business as an (aptly named) lifestyle practice. And for those in the reinvention season, there are opportunities to start a job at a different type of firm, start their own firm, or even support the industry without working directly with financial planning clients. And just as Fall is not necessarily ‘better’ than Spring, no one career season is better than the others. The key for an individual is to identify which ‘season’ they want to be in at a given time and adjust their career plans accordingly!
We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!
In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.