Enjoy the current installment of “weekend reading for financial planners” – this week’s issue kicks off with three interesting practice management articles: the first suggests it may be time for advisors to re-evaluate the value of serving smaller clients, who PriceMetrix finds are 108 times more likely to leave their advisor than become a large client while with the same advisor; the second looks at the tendency for advisors (even/especially fiduciary RIAs) to selectively discuss/disclose their fees but not fully explain all underlying fees; and the third examines the emerging trend towards financial advisory firms engaging in mergers and acquisitions to grow and reach scale.
From there, we have a wide array of technical articles, including: a look at fascinating new research that suggests that immediate annuities may be far less effective than previously posited due to how they are impacted by unexpected client health events; new estate planning trusts that focus more on the income tax opportunities at death (e.g., step-up in basis) rather than avoiding estate taxes; the implications of this week’s announcement to delay the employer mandate for the Affordable Care Act; important things to know about the new state health insurance exchanges (which are still scheduled to open up in October!); how to plan for Social Security dependent benefits and why it’s not always a good idea to delay until you’re age 70; and the latest from PIMCO’s Bill Gross about how the rising turmoil in bonds may be troubling but it’s not time to abandon ship.
We wrap up with three final articles that look a bit more inward: the first is from the Farnam Street blog and provides tips about how to quickly build rapport with someone when meeting for the first time (e.g., a prospective client!); the second is an introspective look from the Wall Street Journal’s Jason Zweig about the challenges of saving investors from themselves and why it’s a worthwhile effort to pursue anyway; and the last delves into some of the latest research about the connections between money and happiness and how to utilize more money to ensure it really brings more happiness. Enjoy the reading!
(Editor’s Note: Want to see what I’m reading through the week that didn’t make the cut? Due to popular request, I’ve started a Tumblr page to highlight a longer list of articles that I scan each week that might be of interest. You can follow the Tumblr page here.)
Weekend reading for July 6th/7th:
Should You Abandon Smaller Clients? – Recent research from industry consulting firm PriceMetrix suggests that small clients are even more problematic for firms that many realize. The average household with less than $100,000 in investable assets pays their advisor only about $30/month, which barely covers basic account costs, and hardly justifies spending much of any face time with the client; having too many, then, can threaten the profitability of a firm and its ability to deliver on its value proposition to core clients. While many firms hold onto smaller clients with the hopes they will become larger ones someday, the PriceMetrix data find that clients with $100,000 or less in assets are 108 times more likely to leave the advisor than become big while with that advisor; in fact, even clients with less than $250,000 in assets appear to “directly and negatively affect an advisors’ growth rate” according to PriceMetrix research. Outperforming advisors have proportionately fewer small clients and work proactively to decrease their proportion of small households; in fact, the research even found that the more small clients an advisor has, the higher the attrition rate of the largest clients, too! Responses from several firms still criticize the idea of shedding smaller clients, who not only have the potential to grow into bigger clients (however remote that may be), but also have the potential to refer bigger clients, too. Nonetheless, the firms that are serving smaller households effectively have still focused on segmenting services to smaller households (and even which advisors serve them), to ensure it can be done in a cost effective manner.
Why Selective Fee Disclosure Is Not A Winning Strategy – From RIABiz, this article discusses how advisors disclose their compensation, making the interesting point that even advisors who are otherwise clear about the fees they charge still aren’t always fully disclosing all the fees, including underlying investment management fees, wrap/TAMP fees, mutual fund and ETF fees under that, etc., engaging instead in a practice of “selective fee disclosure” (telling clients some of the story and not all of it), ostensibly under the assumption that clients just need to know how much the advisor gets paid and can’t handle the truth of what it all adds up to. In fact, a recent survey by Paladin Advisor Research & Registry found that a mere 14% of advisors voluntarily discuss all these fee and cost details, and the majority say they try to minimize discussion on these topics. Yet Paladin finds that such an approach is likely harmful with the clients the firms are trying to reach, as their research also found 80.7% of surveyed investors said they were “most concerned” about various fees and commissions deducted from their accounts and 86.5% said they were “very confused” by the array of expenses, even while only 18.8% said they were comfortable comparing the combined expenses of multiple advisors. Yet while consumers want to know about fees, the research also finds that only 26.3% ultimately select the lowest-cost provide, while 66.3% select who they trusted most; in other words, clients want to know about fees, but don’t necessarily select based on fees (alone), which means proactive fee disclosure that is transparent and builds trust could actually increase the likelihood the prospect becomes a client! The article wraps up with tips about how to have the fee conversation and justify your fees (whatever they are), including your role as a fiduciary (if you’re an RIA), detailing the services you provide, explaining the importance of linking continuous services and continuous expenses to continuous fees, making the case for asset-based fees, and explaining conflicts of interest and how they’re being minimized.
Is Your Practice Big Enough? – From Research magazine, this article aims to tackle the fundamental advisory business question: is bigger really better and worth more, as the focus on growth, mergers, and acquisitions continues to rise? Many industry commentators have suggested the outlook for smaller “lifestyle” practices is grim; the firms haven’t hired, have older clients who are attritioning, are running practices that have little to no real profitability as a business, and are ill prepared for the increasingly difficult competitive environment that lies ahead. While smaller firms struggle, the prediction says, larger firms will increasingly lead the wealth management space, as they have the size and scale to strategize through the challenges and implement the solutions, from staff and servicing to meet client expectations to leveraging technology for efficiency and marketing. As firms seek scale, there appears to be a rise in interest in mergers in particular, as smaller firms pair together to get more mass, and some indicate there’s about to be an explosion in the demand for acquisitions over the next few years as well. Notwithstanding these headwinds, though, the article suggests not all is lost for smaller firms. Some are hearing the message and trying to set the groundwork to grow bigger, and surveys continue to indicate that income for financial advisors is higher than it’s ever been, which means there must be at least some economic value there, though David Grau of FP Transitions suggests that in the end only 8% – 12% of advisory firms will sell to an acquirer, and most with a value below $1 million will just wind down through attrition instead. If you haven’t already, the article recommends that if you want to grow, or just put a number on the value of your business, be realistic about what it’s really worth, network to find potential partners or acquirers, invest more into your hiring process to ensure you hire smart, maximize your business structure to let you spend face time with people, and if you’re really looking at a merger make sure you compare cultures and don’t just look at the money, but make sure you really do the math, too.
Annuity Puzzle Solved: Don’t Buy Them – This article highlights recent research from financial economist Kent Smetters of Wharton (and Felix Reichling of the CBO) on the so-called “annuity puzzle” – why more people don’t buy annuities when financial economics says they should be an optimal solution – and finds that in fact annuities are not nearly as efficient a solution as once believed; in fact, Smetters’ model finds that for most, the optimal annuity allocation would actually be negative, meaning people should be shorting annuities on themselves (i.e., buying life insurance), not buying them! The key issue to Smetters is the uncertainty of health care costs, which necessitate potentially large and uneven bursts of spending at unknown points of time; for workers, that’s the risk of a disability or major health event, and for retirees it’s the uninsured medical costs not covered by Medicare (or even Medigap policies). When the health event happens, a double-whammy occurs: not only is there a big need for liquidity to handle the cost shock (which makes annuities a poor solution), but such events usually decrease longevity as well (which makes the annuity even worse from that point forward, and although you could try to sell it at that point, it will be worth less because of the reduced life expectancy). Which means ultimately, the annuity is an especially poor retirement income tool because its value gets hit more severely than anything else when the inevitable health shocks occur; in other words, annuities might be perceived as being non-volatile and stable, but Smetters suggests it should actually be viewed as a higher beta asset because of how its value fluctuates with health shocks. By contrast, owning life insurance is actually better in such scenarios, because the health shock impact on longevity makes the insurance policy more valuable, which can then be sold (ostensibly as a life settlement) to fund the unexpected health event.
Should Your Clients Be Using The OBIT Instead Of The AB? – This article looks at how to structure trusts for estate planning in today’s environment where “traditional” A-B trust planning (with a marital trust and a bypass trust) has been rendered obsolete for all but the wealthiest clients who no longer face a Federal estate tax. Instead, as estate tax exposure diminishes, the focus is shifting instead to maximizing the income tax benefits of estate planning. While just using a marital trust or leaving assets outright to a spouse avoids the most unfavorable aspects of bypass trusts – including compressed trust tax brackets and the loss of a second step-up in basis at the surviving spouse’s death – this article suggests instead an emerging technique labeled the Optimal Basis Increase Trust (OBIT). Essentially, an OBIT is similar to a bypass trust, in that it limits the surviving spouse’s access to the assets in various ways (not to escape estate taxes but for asset protection purposes), while still giving the surviving spouse a general power to appoint appreciated assets (but just appreciated assets) up to his/her remaining applicable exclusion amount that will cause a portion of the assets to be included in his/her estate. The goal here is to partially restrict access to the trust for asset protection purposes, but still get a step-up in basis for appreciated assets (while not having a step-up in basis for any assets that declined in value). Another approach is to use the so-called “Delaware Tax Trap” technique, where the surviving spouse receives the limited power to appoint appreciated assets into a further trust that grants the beneficiary a presently exercisable general power of appointment; this effectively accomplishes the same result (step-up in basis for appreciated assets without fully surrendering asset protection). The fundamental point: as estate planning increasingly shifts away from estate tax planning, expect complex trusts that maximize and optimal income tax consequences at death, especially regarding a step-up in basis, to become more popular.
What Does The Delay In The Employer Mandate Mean For You And Obamacare? – The big announcement in health insurance this week was the Treasury Department’s decision to delay the implementation of the Affordable Care Act’s “Employer Mandate” (also known as the “Play Or Pay” tax) by one year until 2015, including both the reporting requirements and the penalty tax itself. For many employers, this simply allows them another year to get up to speed on the coming rules and requirements. But for employees (and clients), this creates some potential new complications that will have to be addressed. For instance, employees were only supposed to be eligible for premium assistance tax credits if their employers didn’t offer credible coverage, offered coverage that failed to provide minimum essential benefits, or failed to make the coverage affordable (cost less than 9.5% of the employee’s W-2 income); yet without the employer reporting requirements, how are health insurance exchanges going to determine eligibility for the tax credit? The good news is that for those who really weren’t getting coverage from an employer, or are not working at all, the health insurance exchanges are still scheduled to open later this year to provide coverage for 2014. Nonetheless, the delay has created new confusion, and for those who have been “anti-Obamacare” all along, McClanahan notes that this will likely feed their desire to push again for repeal (though she suggests that repealing ACA without a clear alternative plan to fix our health care system may not be an improvement, either!).
10 Things To Know About State Health Insurance Exchanges – This article provides a good overview of the coming health insurance exchanges themselves, which first take effect in 2014 (though open enrollment actually begins October 1st of this year). The primary purpose of health insurance exchanges is to facilitate the sale of qualified health plans to individuals and also to small businesses, and the exchanges can either be operated by the state itself, or Federally by the Department of Health and Human Services on its behalf. Exchanges will make it easier to compare health insurance plans and their costs by having clearer standards for coverage, and also have responsibility for certifying the health plans on the exchange, providing calculators and cost comparison tools for consumers, and confirming individuals have satisfied the individual mandate rules and whether they are eligible for premium assistance or cost sharing subsidies (and the Federal government will retain some responsibility for overseeing exchanges are implemented properly by states). Other key points include: employers can opt into exchanges with rolling enrollment periods, but once in they are set to one-year periods for the plan (and its premiums); the states so far that operate exchanges have higher costs than most other states, though in part that’s because the plans aren’t allowed to cherry pick healthy people and deny coverage to sick people, and the minimum benefits for new exchange plans are better than the cheaper-but-skimpier policies of other states; employers will have new Exchange Notice requirements to employees to make them aware of the availability of the exchanges (and the consequences of obtaining coverage there instead of through the employer); health insurance brokers and agents will still be permitted, though they must be trained on all health plan options (not just a single carrier).
How We “Found” A Client An Additional $44,000/year: Social Security Dependent Benefits – This article by Ben Birken of Woodward Financial Advisors provides a great reminder of the importance of planning not only for retirement, spousal, and survivor Social Social Security benefits, but also the lesser-known-but-highly-valuable dependent benefits for Social Security. Dependent benefits are paid to dependent children, as well as spouses who are caring for those children; to qualify, children must be unmarried and under the age of 18 (or 19 if they’re still full-time high school students). Disabled children over the age of 18 may also qualify if the disability occurred before their 22nd birthday. With dependent benefits, each qualified child is eligible for up to 50% of the primary worker’s full retirement benefit amount, and a spouse can also receive a 50% benefit until the children reach age 16 (without any penalty for claiming early, unlike normal spousal benefits, though the Earnings Test still applies). In order for any/all of these benefits to kick in, however, the primary worker must have filed for benefits; as a result, for families where dependent benefits are possible, this becomes an important reason to NOT delay retirement benefits, as waiting may raise the primary worker’s individual benefit but can permanently forfeit the dependent payments (as the children may be too old to still qualify after several years’ worth of delays). In addition, it becomes an appealing reason to consider using the File and Suspend strategy, which allows the primary worker to continue to earn Delayed Retirement Credits, even while allowed spousal and dependent benefits to be paid (as long as the worker was full retirement age at the time of the election). Given how many clients have had children (and/or adopted them) later in life, Social Security benefits for dependent children are becoming more and more prevalent, so don’t forget about them!
The Tipping Point – With recent turmoil in the bond markets, asset outflows from bond mutual funds and ETFs have quickly spiked; in this article, bond guru Bill Gross of PIMCO shares his own thoughts on the recent shift in the mood for bonds, drawing an analogy to his time as a young chief engineer on the USS Diachenko who didn’t know how to handle the emergency ballast during a typhoon and had the ship within 1 degree of the tipping point that would have capsized it, and almost necessitating the crew to abandon ship. Accordingly, Gross raises the question about whether the bond market has reached its tipping point, and whether it’s time to abandon ship. Gross notes that he and PIMCO have long been warning that such a tipping point might be approaching, and that “Never have investors reached so high for so little return. Never have investors stopped so low for so much risk.” The surprise, however, seems to be that it’s not just risk spreads that have been widening, but the declines in the “safe haven” of U.S. Treasuries themselves, too, as the Fed’s initial talks of tapering seem to have induced a small market panic as the presence of the “Bernanke Put” on bonds seems to be disappearing. Nonetheless, Gross makes the point that the underlying U.S. economy is not sinking, nor are the majority of global economies, and that this was more a panic of the participants in the market. Ultimately, Gross suggests that the true tipping point has not yet been breached, and that it’s not time to abandon ship, in part because while the economy remains sound the Fed may still be too optimistic (which means tapering may be further away than the market now expects), inflation is still too low (notwithstanding the fears of it rising, right now the Fed’s own statistics indicate inflation close to a mere 1% pace), and that ultimately yields have adjusted by too much too fast and need to come back to reflect a more rational yield curve given where the Fed Funds futures suggest the Fed rates will still be in the coming years. The bottom line: while an inflection point in low yields may have been reached in April, the current bond sell-off is overdone in Gross’ opinion, and while the seas will still be bumpy, it’s not yet time to abandon ship.
Ten Techniques for Building Quick Rapport With Anyone – From the Farnam Street blog, this article reviews the book “It’s Not All About Me: The Top Ten Techniques For Building Quick Rapport With Anyone” by Robin Dreeke to provide some nice tips about how to build rapport quickly with someone you meet for the first time; although not specifically written for financial planners, the guidance is definitely apropos, especially in the context of building a connection with a new prospective client in a first meeting. The key tips and techniques include: establish artificial time constraints (we perceive a first meeting as less risky when we know there’s a limited scope and then it will end); pay attention to your body language, including whether you smile (yes, it really does matter); have a slow and steady rate of speech; start with a theme of seeking assistance; make sure you suspend your own ego and don’t make the whole meeting about you; validate what the other person is saying by showing you’re listening and demonstrating thoughtfulness in your comments; ask questions that start with How, When, and Why (because you can’t just answer them with a brief yes or no); share something personal about yourself to create a quid pro quo environment for getting the other person to share, too; give a gift (from non-material compliments to tangible material gifts, it helps!); and manage expectations by being clear about the agenda and what’s expected.
Saving Investors From Themselves – This article from Wall Street Journal writer Jason Zweig, who recently authored his 250th “Intelligent Investor” column and won a prestigious Gerald Loeb Award for Personal Finance, looks back at his efforts over the years, summing them up succintly: “My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself, because good advice rarely changes, while markets change constantly.” The article takes a good look at the challenges of providing good advice in today’s marketplace, where most of the media thrives on feeding the obsession of chasing whatever is hottest latest while trying not to admit that they may be part of the problem and not the solution. Zweig acknowledges that, in the words of Benjamin Graham himself, “The investor’s chief problem – and even his worth enemy – is likely to be himself” and as a result sees himself in a role to help people bet on regression to the mean (instead of chasing what’s hot), and push back against investors instead of pandering to them. Doing so is often quite unpopular – especially in a role as visible as the Wall Street Journal – necessitating the growth of a very thick skin, and an acknowledgement that it will never be possible to convert all readers, and at best only a few may be reached. Nonetheless, despite the fact it’s not possible to save everyone, Zweig acknowledges nonetheless that the efforts to do so are fundamental to realizing some dignity and meaning for our lives. While written from the perspective of a journalist, I suspect Zweig’s experiences – and his introspections about them – will resonate for many planners as well.
Using Money To Buy Happiness – This article in Scientific American looks at some of the latest research on the connections between money and happiness, as discussed in the recent new book “Happy Money: The Science Of Smarter Spending” by Michael Norton and Elizabeth Dunn. Not surprisingly, the research does find that there’s no simple “more” relationship, where just having more money gives us more happiness. However, that doesn’t mean there’s no relationship between money and happiness at all. Instead, what the researchers find it that it’s less about how much we have, and more about how we spend it; the “right” spending decisions do bring happiness, and to that extent, having more money to spend on things that contribute to our happiness can lead to more happiness. So how should people spend their money? Simply put, the key is that spending should not be on “stuff” (gadgets, music, books, etc.), but on “experiences” instead. So instead of buying a $4,000 high-end TV, buy 40 wonderful meals with a partner or friend for $100 each (which helps not only for the experience of the food, but also the experience of more social interactions than sitting alone watching TV). And notably, sometimes anticipation of the experience can have a positive impact, too; the researchers actually find that the weeks leading up to a vacation also mark a measurable increase in happiness, as we enjoy looking forward to escaping from the cubicle to the beach almost as much as we enjoy the beach itself (and similarly, that limiting our access to something we enjoy, like chocolate, and then having it again and “making it a treat” makes it more enjoyable too)! The researchers also suggest that it’s even better if the vacation can be paid for up front, not at the time or on the credit card that has to be paid off later; paying for everything upfront frees us from worrying about the costs as we go, and lets us get even more from the experience. Of course, the caveat to all of this is that if you spend too much time getting money to buy experiences, and not enough time on the experiences, the happiness doesn’t come. Accordingly, the researchers note that one of the biggest mistakes we all make with our money is that we fail to use it in ways that maximize the amount of time we spend in engaged in activities that make us happy. Good food for thought for clients, and many of us as planners, too!
And although it’s not specifically included here for Weekend Reading, I’d also highly recommend checking out Bill Winterberg’s “FPPad” blog on technology for advisors, including his weekly “FPPad Bits And Bytes” update on tech news and developments!
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!