Enjoy the current installment of “weekend reading for financial planners” – this week’s edition starts out with a big announcement by NAPFA that the fee-only organization is capitulating to the CFP Board on the definition of “fee-only” and will be changing its membership criteria to align with the CFP Board’s own compensation definitions, eliminating the previous option for members to have an up-to-2% stake in a commission-related entity.
There are also several other regulatory-related articles this week, including FINRA’s decision to withdraw proposed Rule 2243 that would have required brokers to disclose to clients the compensation they receive for switching broker-dealer firms (though the rule may be re-proposed later this year), a warning from Laurence Kotlikoff that the SIPC protection consumers rely upon for their brokerage accounts in the event a broker-dealer fails may be less secure than most believe, and a discussion from industry commentator Bob Veres about whether Wall Street has drifted too far away from its fundamental societal purpose of helping businesses to access capital through the capital markets.
From there, we have a few practice management articles this week, including a look at where and how digital marketing fits within the context of a typical advisor’s referral marketing efforts, a discussion of financial services technology startup Motif Investing and its efforts to impact the ETF marketplace for consumers and advisors, and a look at how Amazon and Google may start to disrupt the delivery of financial services products by offering basic term life insurance directly to consumers with online portals and local kiosks where medical examinations can be completed on the spot for nearly-immediate coverage.
We also have a few more technical articles, from a discussion of the different ways that advisors are trying to adapt the 4% rule (and some of the caveats of trying to do so), why retirees who think they might ever need a reverse mortgage in the future should consider establishing one now instead, and how the real problem with accumulators trying to save may be less about our spending habits on coffee and brand names vs generics and more about our unrealistic expectations about how much house, car, and education we can afford.
We wrap up with three interesting articles: the first is written by a venture capital firm about how they view the opportunities and pitfalls for creating a company to “disrupt” financial services; the second is a fascinating look at the recent Pew Research study on political polarization that finds the country really is becoming more polarized (though not necessarily more extreme), and that the trend may get worse before it gets better; and the last highlights a series of “TED”-style talks from the recent Raymond James national conference, where successful advisors who have built strong advisory firms share their own insights and experiences.
And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end! Enjoy the reading!
Weekend reading for June 28th/29th:
NAPFA Changes Membership Criteria – This week, NAPFA announced that it will be “tightening” its membership rules, capitulating to the CFP Board definition that does not allow members to own even a small stake in any financial firm that charges commissions, eliminating the prior NAPFA exception allowing an up-to-2% stake (historically, NAPFA’s financial-firm-ownership rules have ranged from 0% to 5%; it was set at 2% back in 2004). The change brings the NAPFA compensation definition for “fee-only” in line with the CFP Board’s definition, and is estimated to impact as many as 125 NAPFA members, whose situations will now be reviewed on a case-by-case basis (though even if those members depart, NAPFA CEO Geof Brown indicates that it would not significantly impact NAPFA’s budget). Prominent NAPFA member Rick Kahler has noted that this change will likely force him out of NAPFA, due to his significant ownership interest of a family-owned real estate business that generates (real estate) commissions; yet Kahler suggests that perhaps it is time for the conversation to shift from just about compensation to about true fiduciary duty to clients (which he maintains he still provides, even with his ownership interest in a real estate company). Notwithstanding the change from NAPFA, a related article from Investment News notes that tension around the compensation definitions continues, and Brown reiterates his call for a broader dialogue about the issues, “when parties that need to be at the table are ready to be at the table.”
FINRA’s Broker Bonus Disclosure Rule Pulled – This past week, FINRA withdrew its “controversial” proposed Rule 2243, which would have required brokers to disclose (first orally in person at their next time of contact, and then with written notice within 10 days thereafter) to their clients, whenever the broker received recruitment incentives in excess of $100,000 for changing firms. After receiving 184 comment letters, FINRA has declared that it needs more time to address the feedback received; given that the 350-page proposal had already been sent to the SEC for approval in March, the withdrawal of the proposal was a surprise. Nonetheless, even supporters of the rule raised questions about certain details, such as how it could be effectively enforced, and whether the disclosure requirement and associated communication to clients could violate non-solicitation agreements with the prior firm. FINRA has indicated that it plans to re-propose another version of the rule later this year.
Close Your Brokerage Account! – This article by economics professor Laurence Kotlikoff raises concerns about the Securities Investor Protection Corp (SIPC), which provides a $500,000 guarantee to protect customers of brokerage firms in the event that their brokerage firm fails. However, as Kotlikoff points out, the SIPC guarantee may be far less valid than its claims imply. The first issue is that while SIPC provides a guarantee, it protects only the original contributions into an account; in other words, if clients invested $40,000 over 20 years ago, it grows to $160,000 now, and the brokerage firm goes bankrupt, the clients are only protected for their original $40,000 investment from decades ago, not the value today. In addition, if clients take any money out of the account to spend it within 2 years of when a brokerage firm fraud is discovered, the SIPC-appointed trustee can actually sue the clients to recover the funds, on the basis that if there was actually fraud their personal withdrawals are part of the pool to be divvied up amongst all the creditors of the brokerage firm; for instance, if the aforementioned client had taken out $40,000/year for the past 4 years to pay for a child’s college education, the client can be sued by the trustee to recover $80,000 (the last 2 years’ worth of distributions)! Beyond that, Kotlikoff also cautions that even if SIPC had to pay, it is not substantively funded, and since it has no government backing, there may be some question of whether SIPC even could fully pay significant damages if necessary. Ultimately, Kotlikoff advocates for new bipartisan legislation in Congress right now – H.R. 3482 and S. 1725 – that would reform SIPC, including re-defining “net equity” for recovery to be not the client’s original contributions, but the value of their account immediately before the fraud is discovered. In the meantime, Kotlikoff advocates investing directly with mutual funds via their custodians, and not relying on brokerage accounts. (See here a follow-up article with a response by SIPC President and CEO Stephen Harbeck, and Kotlikoff’s subsequent responses.)
Is Wall Street Dangerously Adrift? – In this Financial Planning magazine column, industry commentator Bob Veres shares some thoughts about whether Wall Street has ‘done adrift’, especially in light of the recent claims by author Michael Lewis in his book “Flash Boys” that the U.S. stock market itself is “rigged” in favor of high-speed traders who pay for preferential access to NYSE and Nasdaq computers. While Veres notes that the flash trading is not necessarily doing much to harm long-term investors – who by definition aren’t trading much, and therefore may not be impacted as much as other short-term traders (e.g., day-traders on discount brokerage platforms, or even professional traders) – the bigger issue is that the entire system has drifted quite far from the original and basic purpose of our capital markets: to pool the capital of many individuals to fund complex, expensive enterprises that need the capital to operate and grow and have positive impact on the economy and society (and allow a wider swath of investors to participate in that growth). In turn, the purpose of the Wall Street trading firms is to help provide the liquidity to ensure that investors can enter and exit the investments in such companies as they wish. Yet now, there are estimates that 70% of all trading activity in markets today is machine-to-machine, often with holding periods of 30 seconds or less, and Wall Street firms are creating more and more exotic investments (that are more profitable) than focusing on providing capital to individuals and businesses – which is certainly legal, but increasingly far afield from its public purpose. Ultimately, Veres suggests that this may be a situation where some (proper) regulation can be a positive, to put clearer barriers around what Wall Street can and cannot do, to try to redirect the firms back to their primary societal purpose.
The Information Journey That Makes Prospects Want to Reach Out – From the Blueleaf Advisor blog, this article looks at the principles of digital marketing and how it really works, in an environment where consumers may rely less and less on traditional referrals and more and more on using digital search to find their experts and solutions in the future… or at least, it may be necessary to create a better system so prospective clients who are referred to you actually follow through on making contact. The key issue is to recognize that the old “linear” referral – A refers B, who immediately contacts C – doesn’t necessarily work very well anymore, and instead the reality is that a referral may need to get multiple contacts and connections to you before they actually initiate the next step of a meeting. Accordingly, prospects may ultimately come to you through something more like a funnel – a series of steps and contact points, systematically designed to culminate in the follow-through of a referral. As a result, it becomes very important that your marketing and messaging is consistent across channels; do prospective clients get the same message, whether it’s from the referrer directly, on your website, or via your marketing materials? Once they see this information, is there an intermediate step where a prospective client can be “locked in” such as a mailing list sign-up, so that you can drip market them on an ongoing basis? Conversely, for those who already are clients, are you regularly engaging them in a way that makes it easy for them to refer you, such as sharing expert content with them that they in turn can share with others? Ultimately, the goal is to build a series of ongoing contacts with prospective (and current) clients that builds and supports trust, and making it easier for referrals to follow through with action.
Biggest Thing Since ETFs? – In Financial Advisor magazine, this article reviews investment technology firm Motif Investing, which provides consumers a way to invest in any of thousands of “motifs” available through their website. What is a motif? It’s a collection of stocks or ETFs that reflect a specific idea or trend; for instance, users can invest in a basket of up to 30 securities built around a concept like “Caffeine Fix” (soda/coffee products) to “Cash Flow Kings” (high-cash-flow companies) to “Online Video” (Netflix and competitors) to “Obamacare” (companies positioned to benefit from the new law). Beyond the set of about 145 motifs that the company itself has created for consumers, individuals can create their own motifs (of which there are now about 35,000); investing into a motif costs a flat $9.95 to buy or sell (as a single flat cost for the entire basket of underlying securities), with a $250 investment minimum. The article notes that some advisors have been adopting motifs as a way for clients to save on transaction costs around buying baskets of securities – particularly around investment themes that don’t have their own ETF solution, and/or for clients with smaller account balances where even modest trading fees can take out a big chunk. With so many motifs available now, consumers can get information about the motifs and their underlying investment characteristics, along with returns thus far, directly from the Motif site, before buying the motif or tweaking and customizing it for their individual preferences. More recently, Motif also announced that it will offer a flat-fee wealth management platform for financial advisors who want help building, monitoring, and rebalancing model portfolios, with a cost of $20-$50/month (per client, depending on assets) that covers the technology for onboarding and all trading and rebalancing costs. Ultimately, it’s not clear whether Motif will find momentum, either with consumers or advisors, but they seem to continue the trend of downward pressure on trading costs, and have raise a significant amount of venture capital (including a $35M round a few months ago) to keep building.
Will Google and Amazon Offer One-Click Life Insurance? – The ongoing impact of new technology in the world of financial services isn’t limited to financial advice and investment management; technology solutions are impacting the distribution of insurance products, as well. For instance, those applying for life insurance who need a medical exam can now go online and sign up for an examination at any of 12,000 Walgreens locations around the country, with online results sent directly to the insurer to expedite the process, cutting down the entire process to just a few days. But technology-supported solutions are not only impacting the underwriting of life insurance, but its purchase as well, with the soon-to-be-launched of Amazon Life (ALife), which will allow consumers to buy term insurance online, including the access of medical information and the (electronic) issuance of the policy itself. Google may also get into the fray soon with its “DirectLife” solution, that will allow consumers to get quotes from multiple life insurance carriers and apply for coverage directly; so far, Google DirectLife has been offered from 750 physical kiosks in high-traffic malls (with the medical examination conducted on the spot). The bottom line: tech innovation is coming soon to the purchase of life insurance products, that may greatly expedite the process of obtaining life insurance, and potentially bring down the cost as well.
Retirement Income Strategies: How to Improve on the 4% Rule – From Advisor Perspectives, this article by Joe Tomlinson looks at the “4% rule”, which notwithstanding its ongoing popularity, has its critics as well, including some who suggest the 4% rule is too aggressive, while others claim it’s too inflexible. So what are some alternatives to it? One path is a more utility-based approach, which builds around the economic principle of maximizing lifetime enjoyment of money with a formula that mathematically weights greater negatives to failing goals and less value to excess wealth and upside; when such an approach is applied dynamically on an ongoing basis, the end result is a continuous effort of trying to smooth out consumption from present day until the end of the retirement time horizon (adjusted on an ongoing basis). The upside of this approach is that it can greatly refine an optimal path through retirement; the downside, though, is that it requires quantifying a client’s preferences mathematically (e.g., a personal risk-aversion coefficient and a personal discount rate), which can be difficult to estimate in the real world. Another alternative is the required minimum distribution (RMD) methodology, where retirement withdrawals are simply recalculated annually based on the current value of accounts and a client’s remaining life expectancy, similar to how annual RMDs are determined from the IRAs of clients over age 70 1/2. While in theory these ‘alternative’ methods appear more optimal, Tomlinson notes that may only be because the RMD and optimized methods require annual changes to spending that may be too disruptive for certain clients; e.g., in both methods, a 10% decrease in portfolio values will lead to a roughly 10% decrease in withdrawals (and even worse for a full-on bear market!). As a result, Tomlinson suggests the end point may perhaps be mid-way between these alternatives, using some aspects of the original 4% rule, but making it at least somewhat more flexible over time if/when/as wealth increases.
Apply for a HECM Reverse Mortgage Now – This article from the blog of Tom Davison looks at a recent new research article on reverse mortgages by Gerald Wagner entitled “Apply for a HECM NOW“. The basic premise of the research is to recognize that the FHA’s Home Equity Conversion [Reverse] Mortgage (or “HECM” loan for short) has borrowing limits (up to certain maximum limits) determined based on the age of the youngest borrower, the value of the home, and the 10-year LIBOR swap rate. However, interest rates have been so low in the current environment, that for most of the past 3 years borrowers would have been able to obtain the maximum possible borrowing limit under the HECM program – and even if the funds aren’t needed, the loan can be established as a guaranteed line of credit to be tapped in the future. However, because HECM lending limits are so sensitive to interest rates, a mere % increase in the LIBOR swap rate from its current levels will reduce the borrowing amount available to a 63-year-old by a whopping 20%. As a result, for those who may have any interest in a reverse mortgage anytime in the future, the optimal strategy may specifically be to open the HECM line of credit now, and just let it remain open (guaranteed, and automatically increasing over time) to protect against lower future borrowing limits if/when/as interest rates rise. In addition, the article notes that last fall, the FHA reduced the maximum lending limits by 15%, and some believe lending limits could be decreased again; as a result, opening the HECM line of credit now can lock in the maximum borrowing limit to protect from both increases in interest rates, and potential future regulatory changes that could limit the program down the road.
How to Actually Save Money – From Morgan Housel of The Motley Fool, this article makes the point that for those who really want to save for retirement, the focus should not be on the ‘little’ things like brewing your own coffee or buying generic store products, but on the three big issues that consume most of a household’s cash flow: the house, the car, and education. For instance, despite the fact that median household income has been relatively stagnant on an inflation-adjusted basis for 25 years, the average square footage of a house is up 25%, and the average new American home has more bathrooms than occupants. Overall, the average American family spent 23% of income on housing in 1900, and it was still only 26% in 1950, but it’s 35% today. While many point out that housing has gotten more expensive today, Housel responses that the real change has been that our expectations have moved even more; in the end, most people really can live without multiple guest rooms, several spare bathrooms, and a two-car garage, and some should be seriously considering roommates. A similar problem has occurred with automobiles; yes, many people do need a car to get to work, but not necessarily one that can tow a boat and consumes two-thirds of a year’s worth of income (the average amount borrowed for a car in 2013 was a whopping $27,000!). The same problem exists in the world of education, too; Housel notes that ultimately, most people can receive a solid college education with two years of community college followed by two years at an in-state public university for no more than about $25,000, yet students are picking private colleges that rack up $200,000 of student debt that they just can’t afford. And in the end, when the big issues like house, car, and education are reasonable, it turns out you can drink all the coffee you want!
10 Rules For Disruptors In The Financial Services Industry – This article by Brian Ascher, a partner at venture capital firm Venrock, provides some interesting commentary from the perspective of a VC investor about what is and isn’t appealing for start-up companies trying to disrupt the financial services industry. Ascher’s 10 key rules are: 1) Unlock economic value (by being more targeted and efficient, allowing for lower costs that can be passed on to consumers); 2) Champion the consumer (by building financial services brands they’ll actually want to do business with!); 3) Serve the underserved (it’s easier to open up new markets than it is to fight incumbents in existing ones); 4) Remember the “Service” in Financial Service (just because you’re an online solution doesn’t mean you should deliver everything only by computer, as when it comes to money matters sometimes we want a live person to talk to!); 5) Put a face on it (recognize that successful financial services brands often have a visible face leading them, whether it’s Charles Schwab, Ken Fisher, John Bogle, or Ric Edelman); 6) Be a financial institution, not a vendor (the money isn’t in generator leads for financial institutions, but actually delivering those services directly to consumers); 7) Use technology creatively (e.g., Square figured out how to turn the audio port of a smartphone into a credit card swiper!); 8) Create big data learning loops (pay attention to all that data you get from customers to better understand their issues & what they need, eventually with enough size and scale for significant network effects); 9) Beware the tactical vs strategic conundrum (the profit margin is in helping people with long-term strategic issues like asset allocation, though we’re often more focused on short-term issues like bill paying that’s necessary but less profitable); and 10) Make it beautiful, take it to go (focus on good design and user experience so people really want to use the solution!).
The Single Most Important Fact About American Politics – From Vox, this article digs into the recent results from a massive Pew Research survey of more than 10,000 Americans, which found that “Republicans and Democrats are more divided along ideological lines – and partisan antipathy is deeper and more extensive – than at any point in the last two decades.” Exacerbating this problem was the further finding that the divisions are greatest among those who are the most engaged and active in the political process in the first place. And the striking thing that seems to exacerbate the problem even more is that political polarization is increasingly aligning towards liberal/conservative ideological polarization as well; in other words, Pew finds that 92% of Republicans really are more conservative than the median Democrat, and similarly 94% of Democrats are more liberal than the median Republican, those the numbers were just 64% and 70% two decades ago. Thus, the real blocking point in today’s politics is not merely that we’re more polarized, but that party polarization, ideological polarization, and engagement polarization are all aligning and converging with each other, in a manner that is different than most of our history in the US. At the same time, it’s worth noting that while the American public is increasingly polarized, it’s not necessarily more extreme; there hasn’t necessarily been a big increase in the extremism of views, but simply that Americans are increasingly holding a series of ideologically consistent views that leave them further apart from those on the other side of the divide. This divide in turn is leading to the next major issue: a rising tide of antipathy between the parties, with a dramatic increase in how many Democrats strongly dislike Republicans and vice versa; in other words, while there’s always been partisan bickering and fighting, Pew finds that there really has never been a point (at least in the history of modern polling techniques) that the parties hated each other this much, which is also leading the parties to fear each other (or stoke fear about each other) more than ever, especially since politicians are finding that making supporters angry and afraid is sadly most effective at driving volunteerism, voter turnout, and financial contributions. The end point – and perhaps ultimately the “solution” that Pew finds, is that conservatives and liberals don’t just want different policies, but want to live in different places with ideologically similar people, suggesting that the country may ultimately sort itself into such groups… with the caveat that by doing so, the outcome may only further magnify the polarization. For further detail, you can also check out Pew Research Center’s full “Political Polarization in the American Public” report.
Raymond James Lets Six Advisors Steal The Show At Its National Event With TED-Style Talks – From RIABiz, this article recaps the recent Raymond James national conference, but the real takeaway here is in the second half of the article, which highlights some great real-world advice from advisors who have built successful practices, which was delivered in a series of 18-minute “TED”-style presentations. For some great insights and reminders about the realities of managing a firm, it’s worth reading all the commentary (starting with the subheader “Disengage and delegate”) but the highlights include: View new team members as investments to help you grow; you’ll need about one staff member for every quarter million of revenue you want to reach; delegate the little things and stay focused on developing relationships, enhancing referrals, and prospecting for new clients to grow your business; focus on culture and staff development (they are your firm’s future!); take care of operations, as your business can grow better with solid investments in technology, systems, and processes to make your firm run like a well-oiled machine; get involved in community; take care of people (and they will take care of you); don’t forget how you got here (i.e., respect your lower-tier clients who helped butter your bread); focus on Simon Sinek’s “Start With Why” and communicate it to clients; the steps to success are simply, but not easy; and build a team, because nobody gets everything done on their own!
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. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read “FPPad Bits And Bytes” on his blog!