Enjoy the current installment of “weekend reading for financial planners” – this week’s edition starts out with an interesting new industry study, that finds a significant portion of advisors underestimate and/or understate their own costs to clients, focusing solely on their own advisory fee and not on the total cost including underlying administrative, platform, and/or product/fund fees as well. Also in the news this week were lobbying efforts from the Investment Adviser Association down on Capitol Hill; the organization is putting an increasing push on supporting legislation that would increase the frequency of investment adviser exams, but do so via user fees funded by RIAs (and perhaps with an allocation from Congress as well), rather than allow investment adviser oversight to potentially be shifted to FINRA.
From there, we have several practice management articles this week, including a look at Fidelity’s “Office of the Future” and how technology will (and will not) change the delivery of financial advice, a discussion of how advisors can combat ongoing compression of advisory fees (hint: go big or go specialize!), a review of how some firms are adopting a “financial planning resident” model to bring in young advisors (with an expectation that they’ll only stay for 3 years and then move on and be replaced by the next resident), and a discussion of how AUM advisory firms can use options and hedging strategies to manage the exposure their revenue has to market volatility (rather than trying to convert to a retainer-based business model instead).
We also have a few more technical articles, from a discussion of the pros and cons of Target-Date Funds (while there are some valid criticisms, they are perhaps lambasted too much?), a comparison of the new “simplified” home office deduction to the actual cost method and in what situations each works best, and a discussion of how to properly structure and execute a ROBS (Rollover as Business Startup) plan for clients who want/need to use retirement account assets to fund a new business venture.
We wrap up with three interesting articles: the first is some of the latest research from Julie Littlechild on advisor referrals, who finds that asking clients for referrals may be less effective than asking them for feedback about how to improve your services (which ultimately builds a stronger bond and can lead to more referrals in the end); the second is a discussion from Mitch Anthony in the Journal of Financial Planning about how to reframe “retirement” as a transition to more meaningful work (recognizing that a large number of clients are returning to work after retiring!), and how to facilitate a conversation that balances out the “economic” (money) from the “existential” (meaning and purpose) reasons for work; and the last is a summary of the new book “Keynes’s Way To Wealth” which looks at the fascinating investment experiences of the famous economist, that included two near bankruptcies and investment wipeouts before ultimately focusing more on a long-term deep-value stock investing approach that ultimately left Keynes a very wealthy man. Enjoy the reading!
Weekend reading for June 15th/16th:
Client Fees Likely More Than Advisers Think – A recent survey of advisors suggests that it may not just be clients who underestimate the costs of getting investment advice; advisors, too, appear to be underestimating their own costs of advice, focusing too much of just their own advisory fee and not enough on the total cost to the client including advisor fees, administrative fees, platform fees, and product fees. The survey, conducted jointly by Cerulli Associates and Peak Advisor Alliance, found that while 62.7% of advisors said they believe their clients are paying 1.5% or less in total costs, the average total cost of those advisors surveyed was actually 1.83%. Ron Carson, founder of Peak Advisor Alliance, suggests the results indicate advisors are still not doing a good enough job understanding and explaining their own fees, and helping clients compare the cost of portfolio solutions, especially since in the end what matters most for the client is the total cost and not just the advisory fee.
Advisory Industry Wants More Exams (and Will Pay for Them, Too) – This past Thursday was the Investment Adviser Association’s (IAA) annual lobbying day, and the big focus right now is on how the SEC can better step-up its frequency of exams on investment advisers (an issue of concern for the SEC itself, too, with an estimated advisor exam cycle of once every 11 years), and also how to pay for those additional exams. The IAA is advocating both an increase to the SEC’s funding from Congress and also support for Rep. Maxine Waters’ (D-California) “Investment Adviser Examination Improvement Act of 2013” that would allow the SEC to collect “user fees” from RIAs to fund increased exams (with the fees specifically earmarked for those sole purpose). Notably, though, there doesn’t appear to be much momentum on the Waters legislation, so the IAA is also looking to get a bipartisan bill that mirrors it to be introduced in the Senate as well. In the meantime, the IAA is has also acknowledged that the recent SEC Commissioner Gallagher suggestion of having the SEC use “third-party” examiners is worthy of debate, but that a better solution would simply be for the SEC to reallocate some of its current resources. While it’s not clear whether the IAA will be able to drive the new potential legislation forward, the article does note that advisory industry lobbying did have a significant impact on convincing lawmakers not to support prior legislation that would have appointed FINRA as the regulator of investment advisers (which is still widely viewed as a potential outcome if the SEC cannot ultimately figure out how to improve exam frequency).
Forecast: How Advisors Will Work in the Future – In Financial Planning magazine, advisor technology consultant Joel Bruckenstein examines some of the latest research from Fidelity on how technology is changing the way that advisors work, as Gen X and Gen Y investors increasingly demand it to facilitate communication, collaboration, and accessibility. And to illustrate this, Fidelity has actually built an “Office of the Future” to show how such technology may eventually be adopted (you can even check it out via a virtual tour!). Notably, the Fidelity view is not that technology will replace advisors or lead clients to abandon them, but about finding that sweet spot that brings together human touch with technology, driven around seven key tech trends: mobile, video, cloud computing, the evolving interface, gamification, big data, and social media. For instance, Fidelity suggests that there will be a continued increase in teleconferencing capabilities, including 360-degree panoramic cameras and high-definition live video that will allow for a more immersive experience, which in turn makes it more feasible than ever for advisors to work with clients regardless of geographic location; staff meetings could even include a “telepresence” robot that allows the firm owner to sit in virtually. Mobile technology is also increasingly allowing access to information, whether it’s investment updates to a smartwatch, or virtual keyboards that allow any flat surface to become a keyboard. Another key area of change is the adoption of more collaborative client experiences, including a heavier use of technology – such as a large tabletop-sized tablet – to help clients interact with their plan and financial information (possibly with aspects of “gamification” as well), and large smart-TVs that allows the same experience to occur even if the advisor is in an office and the clients are in their living room at home.
What to Do About Fee Compression – According to data from PriceMetrix, the average fee for new advisory accounts was 1.02% last down, year from 1.04% in 2012 and 1.21% in 2011, and organic growth of advisory assets are slowing (estimated by Cerulli at only 4.7%/year fro 2012 to 2016); the combination of slower growth and declining fees, along with an ever-increasing pressure on the costs of running an advisory firm, suggests that as fees compress profit margins may become increasingly squeezed in the future. As a result, the author suggests there are really only two ways to grow as an advisor in the future: go bigger, or go specialize (i.e., niche). The “get bigger” approach is essentially about trying to get enough size to achieve economies of scale to manage cost, and/or to gain pricing power to push down costs. The approach might be achieved by either trying to team up (advisors partnering with each other), or more substantive mergers, but requires building out effective infrastructure (from relationship managers to technology) to be able to benefit from the size and growth. For advisors who don’t want to get big, or feel that it is too much work/challenge to do so, must find a path to specialization (and make themselves known for it); specialties could include divorcees, or parents of children with special needs, or employees in a particular industry or even a specific company, which in turn means the advisor must focus on the education and networking necessary to learn and connect to the niche, as well as the blogging and speaking to establish themselves as a recognized expert.
Advice Firms Find Residency Programs a Staffing Boon – From Financial Advisor IQ, this article profiles an emerging new hiring approach for advisory firms: “residency” programs, similar to the medical profession, that bring in young professionals with no experience for what is effectively ‘on-the-job’ training (at a relatively low cost price point). The system has been pioneered by Jon Guyton of Cornerstone Wealth Advisors, an advisory firm in the Minneapolis area that created a three-year residency program and hired their first candidate for it in 2010; the idea was to have the residents take on routine operational tasks to free up more time for existing Cornerstone advisors, with the expectation that eventually the residents would become experienced enough after three years to go work in a permanent position elsewhere, and the advisory firm could simply hire another resident. Candidates were tested for both their writing and communication skills, in addition to work-personality assessments. During their first year of actual work, tasks would include preparing cash flow projections and analyzing portfolios, as well as sitting in on client meetings; by the second year, the resident might have a more active role presenting to clients, and by the third year may do even more direct work with clients on specific financial planning tasks. Guyton’s approach has now been adopted by some larger firms as well, including $8B AUM mega-RIA Aspiriant in Los Angeles (which is aiming to have hired 4 residents by the end of the year), which also intends to use the residents for a 3-year term. While Guyton’s vision for the residents was that upon the end of their term, they would move on to another firm (and be replaced with a new resident), other firms are viewing the residency hiring as a path to developing longer-term advisors for the firm itself.
Why RIAs Should Hedge Their Fee Income To Stay Aligned With Client Interests – This article looks at one of the fundamental challenges of the AUM model – that there can be a fundamental conflict of interest between advisors and clients, inasmuch as advisors get more stable revenue in the short term by having more conservative portfolios, even as clients may accept more volatility because they are investing for the long run (which in turn leads to advisory firm revenue that is more volatile as markets move up and down). Some firms have tried to mitigate this challenge by shifting to fixed-fee retainer, though as I’ve previously pointed out on this blog, are highly ‘salient’ and their in-your-face nature can make them more difficult for clients to swallow, and retainer fees can also be harder to grow in the long run (as they don’t always keep pace with long-term market growth) and in a bear market price-sensitive clients paying a retainer fee may actually switch to a (temporarily) lower-priced AUM fee anyway. Accordingly, the author suggests (as also previously discussed on this blog) that adopting options/hedging strategies may instead be a better approach, in a manner similar to how many other industries already hedge the input costs to their businesses (e.g., airlines that hedge fuel costs in the commodities markets). To pursue such a strategy, there are many different choices of options strategies, and the author does advocate a careful analysis of the types of options and hedging instruments available, and consideration of the best way to align the hedging strategies to the goals of the firm, without taking on too much of a cost drag (relative to just remaining unhedged and riding out the volatility).
The Pros and Cons of Target-Date Funds in the Accumulation Phase – In this Advisor Perspectives article, retirement researcher Wade Pfau comes to the defense of Target Date Funds, noting that while they are frequently criticized for not being customized or tailored to individual situations, they were never really intended to be; instead, their purpose is specifically to be the default investment option for those who are not willing or able to put in the effort to take a more individualized approach. Accordingly, target-date funds deliberately follow a relatively simplified “glidepath” that steadily decreases equity exposure from relatively high levels in the early years (when accumulators have less capital at risk, and more human capital as a buffer) to lower levels later (when there is little or no human capital left and an timely bear market can severely impact a large account balance). Nonetheless, Pfau does note several valid criticisms and concerns of target-date funds as well. For instance, by taking risk off the table as retirement approaches, retirees also lose the opportunity to compound the largest gains as the portfolio grows bigger – this is dubbed the “portfolio size effect” – and as a result this “more conservative” approach could leave retirees behind (or at least necessitate additional spending), though the alternative (owning more equities as retirement approaches) could be unduly risky for many. A more practical challenge, though, is the simple fact that target date funds vary tremendously in their own allocations; a 2013 Morningstar analysis of a series of 2015 target-date funds found equity allocations ranging from 8% to 58% for someone presumably two years out from retirement (and in 2008, one 2010-target-date-fund lost 40% of its value from heavy equity exposure!). In addition, target-date funds do not adjust their allocations more conservatively as markets rise significantly, even though clients would likely be more funded for their retirement and therefore likely need less risky asset exposure. Thus, ostensibly a significant value proposition for an advisor may be knowing when, and by how much, to deviate from a target-date fund if/when/as client circumstances (and wealth accumulation and funded ratios) change.
Simplified Home Office Deduction: When Does It Benefit Taxpayers? – From the AICPA’s “The Tax Adviser” publication, this article delves into the new rules for the “simplified” home office deduction, that first took effect for the 2013 tax year. The key change is that while the tax code has long allowed self-employed individuals and certain employees who work out of their home to deduct business expenses relating to the part of their home used exclusively and on a regular basis for business, previously the rules required a rather complex tracking of actual costs and expenses in three tiers (Tier I for interest and real estate taxes on the home, Tier II for expenses to be allocated between business and personal use such as utilities and homeowners insurance, and Tier III for depreciation), while the new rules allow a simple square footage methodology (deduct $5 per square foot for up to 300 square feet of home office space). As the article notes, though, it’s not as simple as just adding up the Tier I, II, and III costs, and comparing them to $5/square foot estimates; for instance, when the simplified method is used, interest and taxes that might have previously been Tier I expenses end out as itemized deductions, but the change in where they’re claimed can impact self-employment taxes and AGI as well (as both are reduced by above-the-line business expenses but not below-the-line itemized deductions). Similarly, the actual cost method may lead to larger deductions including depreciation, but that depreciation is subsequently recaptured on sale, which means a smaller simplified deduction in the short run could actually be better in the long run. Overall, the article finds that as the value of the home increases, the actual cost methodology becomes more appealing and the $5/sqft simplified method is less valuable, especially for homes above $300,000 in value. Notably, taxpayers do get to choose each year whether to take the simplified method or actual cost method (though once simplified is chosen for a particular year, it’s irrevocable for that year and can’t be changed later even with an amended return). To facilitate the comparison, the authors also include an Excel spreadsheet available here to do the actual-cost-vs-simplified-method analysis.
Financing a Business Startup or Acquisition Using [Retirement] Rollover Funds – From the Journal of Financial Planning, this article discusses the key opportunities, issues, and concerns with using rollover retirement accounts to fund businesses, often dubbed “Rollovers As Business Startups” (ROBS) plans. The basic approach is to transfer existing retirement account funds (e.g., a 401(k), 403(b), 457 plan, or an IRA) into a new defined contribution plan, usually a prototype profit-sharing plan where the prototype is amended to allow the plan participants to invest their entire rollover amount into company stock. Accordingly, once the funds are in the account, the participant/owner directs the plan administrator to invest the funds by purchasing stock of a newly created company (which will be fully owned inside the retirement account), effectively “funding” the business startup (and since the funds are all still inside the qualified plan, there is no taxable distribution, income tax event, or potential early withdrawal penalties). Notably, proper execution requires following all IRS and Department of Labor regulations for qualified plans, or the IRS can declare the plan invalid (even retroactively) and then apply taxes and penalties. In fact, the IRS has applied increasing scrutiny to ROBS in recent years, although the IRS guidance has also provided an effective roadmap for how to navigate the rules successfully without adverse tax consequences. Key issues include failing nondiscrimination requirements (as the company grows, don’t forget to cover rank-and-file employees, and remember that if the company stock is a plan investment option, employees may need to be permitted to purchase/invest in company stock too, and be cautious about amendments to limit future investments that might appear discriminatory to rank-and-file employees!), and proper valuation of the stock inside the plan (failure to do so can raise fiduciary concerns for plan trustees, along with concerns of prohibited transactions). For those who wish to move forward, the article details the key steps to effectively implementing the ROBS process, from creating the new C corporation and authorizing issuance of shares, to establishing the ROBS plan and the transaction to fund the business and buy its stock. Also, be aware that fees paid to advisors to implement a ROBS plan should not come from the ROBS corporation’s funds itself, or the IRS may consider these promoter fees (a prohibited transaction), and of course remember to follow the normal annual requirements, including Federal corporate tax returns and an annual Form 5500 (along with a valuation to support the values reported).
Three-Quarters of Clients who Referred their Advisor Were Asked for This – From the blog of advisor consultant Julie Littlechild, this blog article examines the results from her recent “The Rules of Engagement” survey of more than 1,200 financial planning clients, in particular regarding their behaviors around giving referrals. Perhaps the most striking result of the survey was that, despite “conventional” wisdom in the industry, asking clients for referrals is actually a relatively light indicator of actual referral activity. In fact, the survey found that while only 40% of clients who provided a referral in the past 12 months said they were asked for one, 72% of clients who provided a referral in the past 12 months said they were asked for their feedback (via either a formal or informal survey). The reason that satisfied clients don’t tend to refer very often – even when asked – appears to be that in the end, the referral is more about helping their friends being referred (58% of respondents) than about helping the advisor to grow his/her business (only 38% of respondents), so if you ask for referrals to help grow your business you’re actually missing the primary motivator for it. In addition, clients also indicate that they don’t know who to refer; clients tend to try to find people looking for an “advisor” and not people in search of “advice”. On the other hand, asking for feedback – whether formal written/online surveys, or informal advisor-client conversations – appear to be more effective in driving referrals because it creates a sense of partnership and ownership for the clients. Indirectly, asking clients for feedback also appears to be an effective mechanism to remind them of what you actually do for them in the first place; for instance, when you survey clients for their satisfaction about your whole range of services, it’s also a direct remind OF that range of services you provide in the first place! Accordingly, Littlechild suggests that creating feedback mechanisms and using advisory boards can be a strong referral mechanism.
Introducing a New Way to Talk about Working in Retirement – In the Journal of Financial Planning, advisor consultant Mitch Anthony looks at one of the greatest challenges for today’s modern retiree: trying to strike the perfect balance between vacation and vocation, as the high volume of “retirees” who go back into the workplace (at least part time) within their first year of retirement (as many as 60% of career workers) suggests that going from all work and no play to a life of all play and no work is not the right approach. The key issue is that “work” is not just about work; it’s also a way to stay engaged in productive pursuits that help to give life meaning. In fact, the trend of going back to work is becoming so strong, it may even begin to spawn whole new fields of work appropriate for those aged 55-75 (including perhaps providing care to those in their 80s and older). A related trend is an ongoing rise of social entrepreneurship amongst the formerly retired, as ‘former’ retirees start new businesses to drive their encore careers. Given all these dynamics, Anthony suggests that these conversations about the true value of work, the potential for ‘encore’ careers, and engaging in social entrepreneurship, could be introduced by financial planners to their prospective-retiree clientele. To facilitate these advisor-client conversations, Anthony has actually created what he calls the “Retirement WORKsheet” that helps clients understand their own motivators towards work, including both economic (money) and “existential” (meaning and purpose) reasons. This is especially important because the kinds of “work” that clients may pursue can be very different when the purpose shifts from purely economic to increasingly existential factors. Notably, though, Anthony points out that this doesn’t invalidate some of the technical knowledge that planners bring to prospective retirees as well, including real world complications like the interaction between post-first-career part-time work and the Social Security benefits earnings test.
Keynes’s Way To Wealth – This article, by writer John Wasik, looks at the challenges of helping clients navigate investing and volatile markets from the perspective of the great economist John Maynard Keynes, who despite some of his criticisms of capitalism investor was also quite the investor, trader, and speculator as well, both for himself and for several institutions (including King’s College [Cambridge University] and two insurance companies). In his early years, Keynes had relatively limited funds (from his own savings, academic prizes, etc.), though he ultimately set up an investing syndicate including some of his wealthier friends (which many view as one of the first hedge funds), and his primary focus was currency investing, as currencies became ‘unfixed’ and floating in 1914, and Keynes believed he had the advantage of superior knowledge given his work and expertise in international finance; while his trades were initially profitable, they were also highly speculative, and in this first venture Keynes ultimately lost all of his capital after an unexpected surge against his short positions wiped him out. In the 1920s, Keynes shifted to commodities, believing he could profit from his analysis of supply and demand curves; here, Keynes appears to have had better success through much of the 1920s, though again was nearly wiped out after the crash of 1929, ultimately losing some 80% of his net worth as many commodities plunged 50% into the Great Depression. These two cycles ultimately led Keynes to his written masterpiece, “The General Theory of Employment, Interest, and Money” and his ‘behavioral’ view that markets are driven by “animal spirits”. Accordingly, Keynes adjusted his investment strategies again, focusing on the intrinsic value of stocks and essentially becoming a long-term deep value investor, and his results were quite strong. In the end, Keynes’ estate was worth at least $22 million (in today’s dollars), built heavily on his focus on stocks and his analysis of a company’s “earning power” and its ability to survive in a variety of economic conditions.
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!
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.