Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the news that the window for the Department of Justice to appeal the DoL fiduciary rule to the Supreme Court has passed, in what most believe is the fiduciary rule’s final death knell… even as the 5th Circuit’s clerk office has still not actually issued its formal mandate to actually vacate the rule.
Also in the news this week is an announcement by FINRA that it is beginning the process of overhauling the back-end technology that powers the CRD (Central Registration Depository) system that handles all the registration and disclosure details of FINRA-registered representatives (in what is anticipated to be a 3-year technology project to complete), and a fascinating study from the Boston Consulting Group that finds as many as 1/3rd of advisors are discounting their fees despite the fact that a mere 10% of clients are very fee-sensitive and fully aware of what they’re paying in the first place!
From there, we have a number of behavioral finance articles, including the idea from Shlomo Benartzi that clients should “A/B test” their financial preferences before committing to a major financial decision, that our instincts as social animals to compare to other people is a driving force in our financial unhappiness (but can be ‘managed’ by getting a financially healthy role model instead), and a look at how the ongoing force of technology commoditizing products is leading advisors increasingly the direction of handling the more emotional aspects of clients’ financial decisions.
We also have several additional articles on the evolving role of the financial advisor, including a look at how most younger clients actually need more financial advice and not investment advice anyway (which can be evaluated by looking at their human-capital-to-investment-capital ratio), a discussion from Morningstar’s Don Phillips on the rise of the (non-investment) advisor, and an analysis by Bob Veres of how the evolution of the financial advisor over the past 40 years has arguably already so morphed the role of the advisor (and the role that commissions play in incentivizing advisors) that the SEC may be ill-equipped to handle the advisor of the future.
We wrap up with three interesting articles, all around the theme of the role our industry associations play in the financial planning profession: the first raises the question of whether the FPA will once again take up the fiduciary torch by suing the SEC over its watered-down SEC advice rule that exempts brokers from a fiduciary duty (after suing the SEC on a similar version of the same issue – and winning – nearly a decade ago); the second examines the CFP Board’s new Code of Ethics and Standards of Conduct and how the organization has effectively shifted from a “two-hat” approach (with a fiduciary and non-fiduciary hat) into a “tattoo business” where the fiduciary CFP obligation cannot be removed once tattooed on; and the last explores the sticky question of whether we have too many professional associations and designations that create redundant cost and diluted advocacy, or if the reality is that we need multiple designations and associations to have a healthy level of competition amongst the organizations that serve financial advisors in the first place.
Enjoy the “light” reading!
Weekend reading for June 16th – 17th:
DOL Fiduciary Rule On Brink Of Death As Key Deadline Passes (Greg Iacurci, Investment News) – The deathwatch for the Department of Labor’s fiduciary rule continues, with yet another week passing that the 5th Circuit Court of Appeals failed to issue its official mandate to vacate the rule, even as the critical June 13th deadline passes for the Department of Justice to petition the Supreme Court to take up the issue. The possibility of a Supreme Court appeal was viewed as the last – albeit very unlikely – possibility for the DoL fiduciary rule to be revived, after the 5th Circuit struck down the rule, the Department of Labor declined to defend or appeal the decision further, and the court declined efforts by both AARP and various state attorney generals to take up the defense. At this point, it doesn’t appear that there is any feasible means left for the DoL fiduciary rule to be revived, although one remote theory is that one of the judges in the 5th Circuit itself is seeking a rehearing (which can happen if the judge requests an internal poll and the majority of active judges decide to rehear the case). Alternatively, it may simply be that pundits are reading too much into the delay, that the court is administratively simply moving slowly, and the final mandate will be issued in the coming weeks once the court clerk’s office works through its backlog. But for the time being, the DoL fiduciary deathwatch just continues, albeit looking grimmer than ever.
FINRA To Overhaul Broker Information System, Cut Compliance Costs For Broker-Dealers (Bruce Kelly, Investment News) – This week, FINRA announced that it is going to overhaul the Central Registration Depository (CRD) system that processes all broker registrations and disclosures, and powers the back end of the BrokerCheck system for consumers. But the new “WebCRD program” is not meant to be an overhaul of BrokerCheck itself; instead, it is intended to make it easier for firms to complete the registration process (e.g., U-4 and U-5 filings, submitting fingerprint cards, etc.) in a paperless manner, submit and manage disclosure events that must be reported, and be able to better manage the related workflows. In addition, the restructuring of the CRD system is also expected to make it easier for broker-dealers to screen their registered reps, spotting those with problematic work histories, or who are behind on their FINRA CE requirements. The first stage of the overhaul project – a pilot program with a new CRD interface that notifies firms of important action items – is already underway, and will be available to all FINRA-registered firms on June 30th, although the full overhaul of the system isn’t anticipated to be completed until 2021.
Stop Discounting, Your Clients Don’t Care (Charles Paikert, Financial Planning) – In its latest “Global Wealth 2018” report, the Boston Consulting Group finds that nearly 1/3rd of financial advisors charge their affluent clients less than their “target” (i.e., full rate) pricing levels, despite the fact that a whopping 90% of clients report that they are “not fully aware of what they pay” in the first place, and that clients report that trust (not price) is the driving factor in selecting a wealth manager. In other words, advisory firms appear to be discounting their fees to compete for business when it’s not actually necessary to do so, and that even as clients appreciate discounts as a gesture, “they often do not remember details such as the specific amount in question”. And given the rising risk of a bear market – if only because we’re now more than 9 years into a bull market – the “decision” of so many advisory firms to unnecessarily discount their fees raises the concern about whether advisory firm margins may be too thin to withstand the impact of the next bear market, especially since firms may be able to boost their revenues by as much as 8% to 12% simply by “correcting” unnecessary discounts (most of which would drop directly to the bottom line as margin improvement). Of course, for some advisory firms and their prospective clients, discounting may still be (or at least feel) necessary to win business; but failing anything else, the BCG report highlights that in most cases, a temporary discount that ends should be more than enough to win the client, without impairing the firm’s longer-run profitability!
It’s Time To A/B Test Your Financial Life (Shlomo Benartzi, Wall Street Journal) – One of the fundamental challenges in making decisions about financial (and other) trade-offs is that it presumes we actually know what we want and will enjoy in the first place… even as we often end out regretting our decisions and misjudging what it is that will really make us happy, from thinking we prefer the big house (and then deciding it’s too much to maintain) or that we’ll enjoy the fancy new car (only to realize we don’t drive it enough to really enjoy it much anyway). Accordingly, Benartzi suggests that it’s a good idea to try “A/B testing” our preferences instead, where – like a technology company trying to decide which of two options is better – we test two alternatives side by side to see which one we actually enjoy more. The concept is already being applied to various types of investment and savings strategies – for instance, people are far more likely to enroll in a program to save $5/day than $150/month, despite the fact that they average out to being nearly equivalent) – but Benartzi suggests using it as a way to evaluate our own preferences, too. Some examples include: try buying a few luxury and basic goods and use each side by side, to decide if you really think the more-expensive luxury item is worth the cost; test-drive your retirement dream (e.g., to be able to play golf for 7 days a week, or to live in Florida or Phoenix) before making a full commitment, to make sure you really enjoy the lifestyle you think you will; test what retirement lifestyle you really want and need by maintaining your current lifestyle at that projected (higher or lower) level for a few months, to see if it really makes you more or less happy; and remember that we tend to only evaluate trade-offs we’ve experienced, so if you really want to increase your new happiness, you need to occasionally engage in new A/B tests to try out new things as well!
Is Instinct Eroding Your Financial Health (Sarah Newcomb, Morningstar) – As social animals, human beings have an innate need to evaluate our worth and contribution to society, and when we lack an objective measure to do so, often look to “similar others” to judge our progress. Yet unfortunately, in turns out that we’re not even very good at selecting who we should be comparing ourselves to in the first place; instead, recent Morningstar research finds that people in every income group were more likely to compare themselves to people they see as better off than those as worse off, which in turn were associated with higher financial stress, lower satisfaction, lower savings, and more negative feelings about our own lives as we feel like we’re failing to “keep up with the Joneses” (and their perceived good/better fortune). In fact, Newcomb found in her research that actual objective measures related to financial stability – like age, income, education, and financial literacy – were less predictive of financial well-being than our subjective social comparisons! Notably, though, one small group in the research managed to buck the trend – those who didn’t compare themselves to other peers, family, friends, or colleagues… and instead compared themselves to a financial role model or mentor. And in a follow-up study, the researchers affirmed that those who choose financial role models really are significantly more likely to report being confident about their own ability to reach their financial goals (and also reported feeling more determined to reach those goals, and more in control of their financial future). Which suggests that one of the best paths that financial advisors may have to help their clients be more financially responsible is not simply to give them advice on what to do, but to actually be their role model in doing it!
Emotion-Driven Planning Will Accelerate Soon (Mitch Anthony, Financial Advisor) – The financial advice industry is on the cusp of a technological transition akin to the introduction of the automobile in the era of horse-drawn buggies… which notably didn’t displace the drivers (who simply went from driving carriages to driving cars), but substantially altered what the driver drove, and how people get around. Similarly, Anthony suggests that the technology revolution underway in financial advice will transform the role of the advisor, who will still be involved in helping clients make progress towards their goals, but will do so by a substantially different means and focus – one that is focused more than ever on helping people navigate their emotional decisions around money. Notably, Anthony was also the one who coined the term “financial life planning” in his book “Your Clients For Life” nearly 15 years ago, and while life planning has still been relatively slow to go mainstream in financial services, Anthony anticipates that technology will soon accelerate the shift, as the core financial planning question goes from “Do you have enough money?” to instead “Are you managing your money in a way that improves your life?”. Which will necessitate a shift for the advisor from having financial knowledge to becoming a student of financial behavior instead, as portfolio review meetings become “financial accountability dialogues” instead.
Get Financial Advice First, Investment Advice Later (Christine Benz, Morningstar) – There’s a common view that financial advice automatically equates to investment/portfolio advice… which isn’t entirely surprising, given the focus of financial advisors on the AUM model, and the broader focus of the financial services industry on gathering assets into various financial products. Yet when it comes to younger clients in particular, investment advice is often the last bit of financial advice on their minds – which arguably is actually good, as other early-career decisions really are more significant to the individual’s long-term financial success. And of course, the issue isn’t necessarily just a function of age, as some younger investors do have substantial financial assets that they need help with, while many older investors still don’t have all that much saved up (and need more help in other non-portfolio areas). Accordingly, Benz suggests that the best way to evaluate the situation is to look at someone’s “Human Capital / Financial Capital” ratio, where those who are young but have a good degree in a lucrative field may have a substantial “human capital” asset but zero or even negative financial assets thanks to student loan debt (and thus a very high ratio), while those who are older with fewer working years remaining but more assets saved up have a lower ratio (less human capital and more financial capital). Which means the size (large or small) of someone’s human/financial capital ratio can itself provide a good benchmark to understand where they should focus, as those with high ratios (lots of human capital and less financial capital) need to focus more on managing cash flow and saving (because the impact of contributions to the portfolio will be actually greater than the impact of growth in the portfolio) and less on asset allocation (simple diversification with index funds should do fine), while it’s only those who have a lower ratio (and larger portfolio) that really should spend time going deeper into the portfolio issues (because the portfolio is large enough for those decisions to really matter at that point!).
The Rise Of Non-Investment Advisors (Don Phillips, Morningstar) – With the ongoing commoditization of investment products thanks to technology, investment advisors themselves are effectively being pushed out of the “investment” business altogether, morphing into financial planners and relationship managers instead. Which is a dramatic shift from the days of old, where “advisors” defined themselves as stock-pickers (using their own research or that of their parent brokerage firms), only to morph into becoming selectors and evaluators of mutual fund managers (as technology drove down stock trading commissions after they were deregulated in 1975) with positive incentives to better serve their clients (than just sell whatever their brokerage firms recommended/wanted to sell), and then shift again into a focus on asset allocation (and the use of index funds) as the available alpha on mutual funds decreased and academic research suggested most advisors (or investors) couldn’t find and pick persistent mutual fund winners anyway. Yet again, as investment recommendations become more and more standardized – towards low-cost asset-allocated portfolios – the role of the advisor in the investment decision-making process is itself reaching its logical conclusion… that advisors are playing less and less of an investment role at all with clients. Which, ironically, leads Phillips to raise an interesting question – what is the role of fiduciary regulation for an advisor’s investment recommendations, when advisors are less and less involved in the selection of those investments in the first place?
The Diminishing Future Of Investment Advice Regulation (Bob Veres, Inside Information) – The basic gist of the SEC’s new advice rule is that broker-dealers will be held to a “best interest” standard (that in practice is still very similar to the existing suitability rule), and to provide a new “Client Relationship Summary” (Form CRS) document that would highlight to clients whether their advisor is subject to a fiduciary duty (as an RIA) or Regulation Best Interest (as a broker) instead, and must highlight the differences in costs – including the acknowledgement that for those who don’t want to trade often anyway, working with a commission-based broker and paying by the transaction may be cheaper than working with a (fiduciary) advisor. Veres suggests that this framework highlights that the SEC itself seems to have veered off from the roots of its original regulatory intent; after all, for the first 30+ years of the SEC, a “commission” was simply something paid to execute a trade (akin to the transaction fees that custodians still charge today), and it wasn’t until the shift towards the independent broker-dealer movement after 1975 that a “commission” shifted to something that was actually meant to incentivize a broker to sell a product. But that shift in commissions led to an important subsequent shift – where companies suddenly could compete not based on merit and the quality of their solutions, and instead could compete with the incentives they paid to brokers to sell their products… culminating in even brokers themselves no longer vetting and evaluating what they were selling (as Nick Murray famously quipped “You don’t have to know how a watch is made to sell a watch”). On the other hand, with a second shift in the industry underway now – from investments towards more comprehensive financial planning, which the SEC doesn’t actually regulate outside of its investment-advice-specific focus – Veres raises the question of whether eventually, financial planners will just start to charge for planning fees alone, give away the investment advice and portfolio management for free, and leverage the SEC’s own Form CRS to “disclose” that their cost for investment management services really has gone to zero? Which, ironically, could make the SEC’s regulatory effort even less relevant in the future than it is today?
Will The FPA Sue The SEC Over Its Best-Interest Rule? (Tracey Longo, Financial Advisor) – It was almost exactly 10 years ago that the Financial Planning Association won its lawsuit against the SEC and forced the agency to vacate its so-called “Merrill Lynch rule”, that had allowed brokers to be exempted from RIA registration (and a fiduciary duty to clients) while providing fee-based accounts to clients. Which raises the question, as the SEC once again proposes a new rule that would allow brokers to offer more investment advice to consumers without being a fiduciary, whether the FPA may look to sue the SEC again? Thus far, the FPA isn’t providing much indication either way of its intentions to file suit against the SEC (or not), but at its recent FPA Advocacy Day in Washington DC, the FPA did focus its efforts on the fiduciary issue and the importance of having consistent fiduciary regulation of advice across the board. Of course, the ironic reality is that as long as the SEC does not impose a uniform fiduciary standard on all financial advice, RIAs and those with CFP certification who are subject to a fiduciary standard can effectively differentiate themselves on the basis of their higher standards. Although given the similarity of language – that RIAs are subject to a fiduciary duty requiring them to act in the best interests of their clients, while brokers would be subject to Regulation Best Interest that requires them to make recommendations in the best interests of their clients – it’s not entirely clear that consumers will even be able to understand the differentiation in the first place!
CFP Board Enters The Tattoo Business While SEC Flounders (Dan Moisand, Financial Advisor) – Earlier this year, the CFP Board officially announced the adoption of its new Code of Ethics and Standards of Conduct, which states that “at all times when providing Financial Advice to a client, a CFP professional must act as a fiduciary, and therefore, act in the best interests of the Client.” The significance of this “fiduciary at all times” language is in how it contrasts from the prior rule, which only stipulated that the CFP professional was subject to a fiduciary duty when doing financial planning, and not simply by being a CFP professional providing (any kind of) advice. In other words, previously it wasn’t always clear when a CFP professional was acting as a fiduciary or not, and there was a possibility that the planner could put the fiduciary hat on (to do financial planning) and then take it off at the implementation phase. Or as Moisand puts it, the CFP Board has now effectively entered the “tattoo business” (despite substantial opposition from the broker-dealer community), where CFP professionals are effectively tattooed with the CFP-fiduciary label… which cannot be removed as easily as the two-hats fiduciary obligation of the past. On the other hand, Moisand also notes that this obligation does potentially put at least some brokers in conflict with their broker-dealers, raising the question of whether/how broker-dealers will adapt to support their CFP professionals, or whether CFP professionals will move to alternative platforms and providers more willing to support them, especially as the broker-dealer community defeated the DoL fiduciary rule specifically by “proving” that their brokers do not give trusted advice and are solely in the business of selling products. Because given how hard advisors work to earn the “CFP tattoo” in the first place, it’s not likely many of them will be willing to relinquish the marks now.
The Future Of The FPA, The CFP Board, And The Organizations That Run The Planning Profession (Bob Veres, Advisor Perspectives) – The proliferation of various professional designations for advisors over the years has created frustration not only for consumers trying to figure out which are legitimate or not, but also amongst financial advisors themselves, who struggle to figure out which ones are the best to pursue, and which of their related associations to join. On the one hand, such a range of associations and designations creates substantial inefficiencies and redundancies in the system; but on the other hand, having multiple organizations also promotes a healthy level of competition, relative to granting one organization a virtual “monopoly” on designations and/or association membership. Yet in practice, the two don’t have to be mutually exclusive, either; for instance, in medicine, the MD degree is the baseline requirement for all, and then additional designations and specializations have built up around it (akin to having CFP certification as the minimum standard baseline, and other post-CFP designations crop up around it), which in turn may have multiple association groups representing those specialized constituencies. Still, though, to the extent that associations typically fulfill four core functions – providing CE, advocacy, communicating the benefits of the profession to the public, and providing networking opportunities – arguably a consolidated organization could have dramatically better economies of scale to accomplish these goals at a lower cost… not to mention a better-focused advocacy agenda than the current fragmented approach. At a minimum, though, Veres suggests that the associations should at least do a better job of coalescing around common goals and advocacy positions – such as clarity around titles, standards for certification and continuing education, and workforce development/talent recruiting – finding common ground on advocacy issues where size confers greater “clout” in Washington, even if the varied individual member benefits of each association maintain a healthy level of competition.
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
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 as well.