Enjoy the current installment of "weekend reading for financial planners" - this week's edition starts off with an interview with Michael Branham, the incoming president of the Board of Directors for the Financial Planning Association (and the youngest person to ever take on the role), as he discusses the outlook for the FPA in particular and the financial planning profession in the coming year. As the first Weekend Reading of 2013, we continue with a number of additional articles taking a final retrospective look at 2012 and a fresh look at 2013, including a look back at the major financial regulatory events of 2012, a prospective look (and wish list) by fiduciary guru Ron Rhoades on potential regulatory activity for advisors in 2013, a look from Bob Clark at how FINRA took some big hits in 2012 but may not be out for the count yet, and a projection by Bob Veres of a dystopian future for advisors if FINRA gains control (can you sense a theme regarding the looming regulatory battles regarding the fiduciary standard, the oversight of investment advisers, and a general dislike of FINRA?!).
We also look at a few other idea and trends articles for the coming year, including an intriguing idea of how financial planning could be brought to the masses to be funded by a tiny tax applied against the rest of the industry, and a look from yours truly in the Journal of Financial Planning about how the "new normal" environment is impacting the growth of financial planning firms. From there, we look at a few investment-related articles, including a discussion by Bob Veres about best practices for firms that use investment committees, a brief article explaining the best ways to determine if your (client's) annuity carrier is safe, and an interesting article from GMO about the challenges of investing for clients in "the age of financial repression." We wrap up with three somewhat more "offbeat" articles: the first looks at the ongoing rise of "gamification" to induce consumers to change their behaviors (for better and for worse); an important reminder not to assume you know what your customers really want (or to get stuck in an echo-chamber by only asking your best clients if they're still happy); and a striking discussion of recent research that shows how we consistently underestimate how different our future personality and tastes will be in 10+ years from what they are today, which has profound implications for how we attempt to establish financial planning goals for clients. Enjoy the reading!
Weekend reading for January 5th/6th:
Michael Branham On Unifying The Profession And Building The Next Generation Of Planners - This is an interview in the Journal of Financial Planning with Michael Branham, incoming president of the national Financial Planning association and former president of the FPA NexGen group, looking at the direction of both FPA and the profession at large in the coming year. Highlights for FPA include: continuing to refine its new organizational structure (related to recent shifts in the FPA's strategic directive to be more focused on members, and under the leadership of new FPA CEO Lauren Schadle); bringing chapters on board with the new strategic focus; accelerating the conversation regarding bringing in the next generation of financial planners; and taking a look at the longer-term future of the FPA as more and more students enter the profession. Notably, Branham brings a new perspective relative to prior FPA leaders; he was not a career changer and started in the profession (and still remains) as an employee, not the founder of a financial planning business, and as a result acknowledges that the challenges facing young planners today are different than what veteran financial planners once faced in their early days. At the same time, Branham notes the importance of building upon the foundation that exists for financial planning, and ensuring that there is a legacy for the founders and veterans of the planning profession.
Financial Regulation: What Changed in 2012? - This article from Financial Planning magazine provides a nice overview of the financial regulatory changes that occurred over the past year. Enforcement actions from the SEC soared in 2012. The SEC also increased the amount of assets it oversees, as small advisors shifted to state registration due to the new $100 million threshold requirement, but a number of large private asset managers shifted themselves to SEC oversight to avoid some new Dodd-Frank rules (and even some still-exempt funds had to at least file a Form ADV to register with the SEC). For advisors working under broker-dealers, the new suitability rules rolled out in July, which are generally viewed as lifting the standard for affected advisors to act more in the interests of their clients (albeit still not at the level of a true fiduciary duty). Perhaps most colorful in 2012 - although not ultimately coming to a resolution - were the ongoing debates regarding the implementation of a uniform fiduciary standard (which may be coming in 2013), along with the debate about how investment advisers should be overseen in the future (the so-called "SRO debate" between the SEC, FINRA, and/or a new standalone SRO). Other highlights include the Department of Labor's own efforts to implement fiduciary rulemaking under its scope (which may also be forthcoming in 2013), and ongoing money market reforms to reduce the risk of another 2008-style crisis.
The Fiduciary Landscape in 2013 ... And a Wish List - On his Scholarly Financial Planner blog, fiduciary guru Ron Rhoades takes an interesting look at what may be on the horizon for 2013 regarding the implementation of a fiduciary duty for those who deliver investment and financial advice. Rhoades anticipates the biggest issue in the near term will be the (re-)release of a revised "Definition of Fiduciary" rule from the Department of Labor, likely due out in early or mid-2013. It is expected to apply a strict ERISA-style fiduciary standard to anyone who provides investment advice to plan sponsors or plan participants, may extend the fiduciary standard to IRA rollovers, and should be accompanied by a substantial economic analysis (which may in turn help to support and substantiate fiduciary rulemaking for the DOL and in other contexts as well). Although the rule will likely be hotly contested, Rhoades predicts that it will ultimately be adopted, noting that the DOL is already seeing that mere disclosure requirements (even with its new fee disclosure rules) are not enough. As for a uniform fiduciary duty for all advisors, Rhoades suggests that the SEC may still kick the can further down the road and not take up the issue in 2013, although he notes that state courts are increasingly applying a fiduciary duty to many registered representatives for financial and investment advice anyway, and more and more advisors are becoming CFP certificants (which applies its own version of a fiduciary duty). On the other hand, Rhoades cautions that the SRO debate for RIAs will continue in 2013, and suggests that if FINRA does gain oversight of investment advisers (with stakes rising as Rhoades notes the continued migration of brokers to RIA status already), it will be a death knell for a true fiduciary standard for advice to consumers. In the remainder of the article, Rhoades provides his own longer term wish list for the future, including a true uniform fiduciary standard for all those who provide investment and financial advice to consumers, that FINRA's aspiration to become an SRO for RIAs is rejected, that simply using a title (like "financial advisor") to imply a relationship of trust should automatically trigger fiduciary status, and more.
The Jaws Of Defeat - In his monthly Investment Advisor column, Bob Clark sounds off regarding FINRA's failure to gain oversight of Investment Advisers in 2012, due in no small part to pushback from RIAs themselves who indicated that they were willing to accept increased oversight, but that they would rather pay user fees to the SEC to get it. The landscape is likely to look different in 2013, especially due to the fact that Spencer Baucus (who sponsored the SRO (Self Regulatory Organization) legislation in 2012 that was anticipated to result in FINRA's oversight of RIAs) will no longer be chairman of the House Financial Services Committee due to term limits. Baucus' heir-apparent is Jeb Hensarling, who may not be as inclined towards supporting FINRA. In the face of Baucus' departure, the Financial Planning Coalition is rumored to be pushing the House Financial Services Committee for new user fees legislation, to increase RIA oversight but without FINRA's involvement. However, Clark points out that even oversight of RIAs by the SEC falls short of what may be the ideal: RIAs (and perhaps all financial advisors?) regulated by a standalone SRO that is not tied to the securities and brokerage world at all. After all, the SEC's track record has still often leaned towards its brokerage industry roots, and Clark suggests the "business model neutrality" argument may still result in the SEC delivering a "watered-down" version of the fiduciary standard. Ultimately, though, Clark warns not to count FINRA out at this point, as Wall Street firms may step up their lobbying as they are under duress in the face of slowing growth and a rising tide of broker defections to the RIA model, and having former FINRA executive Elisse Walter as the acting SEC chairwoman in 2013 still keeps FINRA at the table. On the other hand, Clark suggests that if FINRA is defeated again in 2013 in favor of the SEC and user fees (if not a new SRO), it may mark a permanent tipping point away from the historical brokerage model and FINRA for good.
Future Tense For Financial Advisors - In his monthly column for Financial Planning magazine, Bob Veres paints a picture of a dystopian future where FINRA gains oversight of all advisors, and foists so much compliance and disclosure obligations upon them that independent advisors (and even independent broker-dealers) are regulated out of existence; instead, all advisors work for one of two mega-brokerage firms (with two, there's not a "monopoly") as employees, because it's the only way to gain effective scale to manage the burdens of operating as an advisor. In Veres' future world, advisors are "fiduciaries" but the standard is ultimately just a fancy label for what is actually just monitored suitability and an avalanche of disclosure paperwork; similarly, all advisors are "fee-only" but simply because they are paid a flat salary and an end-of-year bonus (which happens to be calculated in a manner that bears a suspicious resemblance to what commissions would have added up to anyway). Veres wraps up by looking back at present day, where it seems "the future couldn't be brighter" for fiduciary, client-centric advisors - with a not-so-subtle takeaway message that the bright outlook could change drastically if FINRA takes control of the whole advisory business.
Financial Planning For All: An Insurance Solution - This interesting article from John Grable in Financial Planning magazine looks at a new "insurance" model to bring financial planning to the masses. But Grable isn't talking about advisors that sell insurance to clients; he's talking about a Financial Planning Service Insurance Fund, which would function in a similar manner to a prepaid legal service or health insurance fund. Advisory firms would fund the arrangement, perhaps with voluntary contributions, mandatory insurance fees, or perhaps even an AUM tax (just $0.01 for every $10,000 in AUM would be a 0.0001% tax but in the aggregate could add up to millions). The funds would be used to supplement nearly-pro-bono advisory services - perhaps paying advisors $25/hour to provide services to those members of the public who otherwise can't afford to pay for financial planning at all. The ultimate goal here is for the industry to self-fund a minimum floor of income for financial planners who wish to provide services by creating a potential "job of last resort" providing financial planning services to the public; the compensation may be low, but at the least it would help to supplement new advisors with a known payor, while bringing advice to the general public. Although some might question whether the details of the numbers that Grable puts forth in his column "work" the concept is nonetheless intriguing.
A ‘New Normal’ Look at Practice Growth - This article in the Journal of Financial Planning is by yours truly, and is an adaptation of a similar article than ran previously on this blog. The basic point is that household wealth in the aggregate has been stagnant for more than 5 years now, just barely reaching the pre-crisis highs; this is a significant departure from the preceding 5 years, where household wealth jumped nearly 70%. As a result of this "new normal" for growth, the financial planning industry in the aggregate has also struggled to grow in recent years, which is leading to a number of secondary trends impacting the advisory business, including: firms reaching for returns (advisor adoption of tactical asset allocation and other active investment strategies); new revenue models (e.g., retainer fees and an increase in standalone financial planning fees); new marketing approaches; the urge to merge (where advisory firms merge together to gain economies of scale); growth by acquisition (where firms seek to grow by acquiring other firms instead of acquiring clients directly); and an outsourcing bonanza (aggressively managing cost to maintain margins). The fundamental point - as long as the new normal continues, advisory firms may be forced to look more at expanding their slice of the pie, rather than just enjoying their slice of a pie that was growing all by itself.
Getting the Most from Your Investment Committee - This Bob Veres article on Advisor Perspectives takes a look at best practices in forming and using investment committees in financial advisory firms, as Veres notes they are becoming a widespread (albeit recent) phenomenon. The starting point is the typical size of an investment committee, which Veres noted generally scales with the size of the practice (small firms might just use two people, while large firms often have half a dozen or more). Meeting frequency may vary from weekly to monthly to quarterly, although meetings tend to occur more often as the investment committee takes on more responsibility, and ideally there should be some planned structure regarding what is covered and when (e.g., first meeting of month reviews the economy; second meeting of month reviews current fund positions; etc.). Most investment committees work (or argue?) until there's consensus, although this structure also varies by firm - some force and require consensus to act, while other firms use the investment committee as more of an advisory council while still leaving final decision-making authority to a single leader (e.g., a Chief Investment Officer). While the consensus approach in particular may slow the process down, the article notes that often firms are willing to exchange some speed and efficiency for an improvement in confidence and professionalism. Do investment committees actually help the firm make better investment decisions? Most firms seem to indicate yes, although what "better" means clearly varies, but with a general theme that more people involved tends to result in more information, more analysis, a more systematic approach to implement the firm's investment philosophy, and perhaps less impulsiveness to the potential whims of one individual (and perhaps improves returns as well, although that doesn't appear to be a priority for a lot of firms' investment committees). Are there any downsides to investment committees? Besides time and resources involved, the article cautions about the potential risk for groupthink behavior (in this context, encouraging more active debate can be a positive!), and to watch out for analysis paralysis.
How Safe Is Your Annuity Carrier? - Although written primarily for consumers, this article from MarketWatch actually provides a nice list of resources for where to look up annuity company (or insurance company) financial ratings. The easiest go-to point is the COMDEX score, which provides a numerical score from 0 to 100 based on a combination of the ratings from other financial ratings services. The next alternative is to get ratings from the ratings services themselves, including A.M. Best, Standard & Poors, Fitch, Moody's, and Weiss (the "big 5" that rate insurance/annuity companies). For further due diligence, check into the details of the state's guaranty fund that backs annuities - information is available at the National Organization of Life & Health Insurance Guaranty Associations (NOLHGA) - and request a copy of the insurance carrier's balance sheet (which most will provide directly, and/or through their investor relations department if the company is publicly traded). The article also provides some guidance about how some of this information is occasionally misused, such as only showing one rating agency (using COMDEX prevents cherry picking because it combines ratings from all agencies) or using the state guaranty fund in the selling process (which is actually illegal in most states).
The 13th Labour Of Hercules: Capital Preservation In The Age Of Financial Repression - This article from the brilliant James Montier of GMO provides an incredible look at the challenges of investing and preserving (client) capital and purchasing power in a so-called "age of financial repression" when projected real returns are abysmally low (or negative for many asset classes), which he equates to one of the mythical labors of Hercules. Montier notes that this is largely a result of the Fed's zero-interest-rate policy and quantitative easing, which in fact is designed to drive risk premia lower to induce spending and speculative investing (in the hopes that it stimulates new business growth and activity). So how should advisors and their clients invest in this kind of environment? Montier warns that the traditional response is the exact opposite of prudent value investing - as the reward for taking risks get lower, investors load up on low-return assets to achieve their desired goals, even though this ultimately means buying large quantities of risky, overvalued investments. This is especially concerning in light of the tail risks that emerge for equities and other risky assets in high valuation environments; on the other hand, owning cash and watching purchasing power erode is not exactly appealing, either! So what's the true solution? Montier suggests that as investors will inevitably swing in such environments between irrational exuberance and the depths of despair, the best opportunity may be an ongoing shift in the asset mix to reflect the ongoing changing conditions. In addition, it is still possible to find value as a long-term investor, but the key is that it first requires adjusting expected returns in light of the anticipated time horizon for financial repression, and only investing when returns can meet/expect that more difficult threshold. Of course, the caveat is that if you anticipate financial repression to last a long time, and it really does end sooner rather than later, then the prices of risk assets may adjust (i.e., decline) sooner than anticipated. While this remains concern, though, Montier unfortunately also notes that it may continue for some time to come, as the average duration of financial repression in history is about 22 years, +/- 12! (Thanks to Daniel Foley for suggesting this article!)
All the World’s a Game, and Business Is a Player - This New York Times article provides an interesting look at the gamification trend - by actually embedding it into the experience of reading the article itself, which awards you made-up "badges" as you proceed through reading the article. The principle is similar to parents rewarding their children with gold-star stickers for chores well done, or airlines awarding elite status to active business travelers, but the trend towards gamification is becoming more and more popular lately, due to both the availability of smartphones and the Internet which make it more accessible, and the simple fact that business are finding it really does impact behavior. It doesn't just have to be about consumption, though; while Foursquare is one example of the trend (providing points and badges for "checking in" at various stores and restaurants), another is a service called Opower that awards badges to customers who reduce their energy consumption (and can compare their progress with neighbors and broadcast their achievements on Facebook). The article provides numerous examples of how gamification is being used within businesses as well, recognizing and rewarding employees for good behaviors with coworkers or customers. While the article is written regarding gamification generally, one can't help but think about the potential applications of gamification for financial planners and their clients as well.
Don't Assume You Know Your Customers - From the Harvard Business Review blog, this article draws on the Republican lesson of the recent election - where Governor Romney and his advisors got so caught up in their own "adjusted" polls that they had no idea they were going to lose on election night - to make the point that while shared enthusiasm and beliefs are important for any business and organization, it's critical not to lose touch with the end customer. For instance, the author notes that financial services in particular is often guilty of this, with a strong tendency to talk too much in its own jargon and terms (compound interest, ETFs, or even fiduciary); as a result, a recent AARP study found that 79% of Americans think prescription drug instructions are easier to understand than materials from financial firms. Yet the reality is that using language and jargon that confuses customers can turn them off and undermine trust and loyalty. So what should you do? The starting point is to try to break away from the company mentality from time to time, and remember what it's like to be a "regular" person instead; in addition, it's crucial to realize and admit that you really might not be connected with prospective and current customers (or clients) as much as you think you are. Perhaps most important, though, is to recognize that if you really want to assess the problem (or whether there is a problem), you need to take a broad look at customers, and non-customers, and ex-customers; if you just ask your best and current customers (or clients), you won't get outside your own echo chamber.
Why You Won’t Be the Person You Expect to Be - This article from the New York Times looks at research on the so-called "end of history illusion" - where we have a tendency to project our future selves as having substantively similar personality and tastes as what we do today, even though in reality we often don't and tend to systematically underestimate how much we will change in the future. Ironically, even though at middle age we tend to look back at our teenage or young adult selves and remark upon the differences, we still fail to realize that our future selves will likely do the same in looking at where we are today. Notably, the research finds that we really do change a bit less in the later years than we do in the early years; nonetheless, we still drastically underestimate the change that is still in store for us, even up to and including in retirement. It's not entirely clear why the phenomenon occurs - perhaps it requires too much mental energy to really vision our future selves, or we just lack in personal imagination, or something else. Nonetheless, the fact remains that we continue to misjudge our tastes and personality in the future. Although not directly addressed in the article, implications for financial planners may be significant; after all, if we systematically underestimate how different our tastes and personality will be in as little as 10 years (not to mention 20 or 30 years), it presents significant difficulties for accurately assessing retirement and other goals!
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!