Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the official news that the Department of Labor fiduciary rule is really, truly, finally dead, as the 5th Circuit Court of Appeals finally issued its formal court mandate to vacate the rule.
Also in the news this week, following on the heels of the demise of the fiduciary rule, is the announcement that both Merrill Lynch and JP Morgan are considering whether to roll back their commission bans on retirement accounts as the fiduciary rule goes away (albeit to appeal to the subset of investors who actually wanted a commission-based account, because they didn’t trade often anyway, and were unhappy that the firms were using the DoL fiduciary rule as an excuse to force them into higher-cost fee-based accounts). And this week’s news also includes an important Supreme Court ruling in the case of Lucia v SEC, finding that the SEC’s administrative law judges are improperly appointed… although ironically, the Trump administration had already begun the process of shifting away from ALJs and towards appointed judges for government agencies anyway!
From there, we have a number of investment-related articles, including: the ongoing (and perhaps inevitable?) grind of mutual fund fees towards zero, as fund families find other ways to get paid instead; how the pressure on mutual fund fees is starting to push upstream to custody and clearing platforms, that often boost the expense ratio of funds by as much as 40bps to cover platform fees that most investors mistakenly thing are going to the mutual fund company and its managers when they’re not; and the last looking at how the rise of technology to manage large numbers of stocks may soon make it feasible for at least do-it-yourself investors to start creating their own rules-based investment algorithms that basically amount to their own personalized index fund.
We also have several additional articles on tax planning this week as well, from IRA planning strategies in 2018, to tactics to better manage investment advisory fees in a world where miscellaneous itemized deductions (including those for advisory fees) are no longer permitted, and a dive into the increasingly popular strategy for high-net-worth investors to get around the $10,000 deduction cap on property taxes by splitting up their real estate and transferring it in slices into a series of out-of-state non-grantor trusts.
We wrap up with three interesting articles, all around the dynamics of finding more productive uses for your time and energy: the first explores how, if you really want more time to connect with family and friends, the key is not to declutter your schedule with fewer obligations, but to add an obligation to your calendar specifically for family-and-friends time; the second looks at how the concept of “antifragility” can be applied directly in our own lives, especially when it comes to taking an ongoing series of small risks that give ourselves opportunity for a big outcome; and the last looks even further at how we can actually promote more serendipitous events in our lives, as research increasingly shows that “luck” is a material component of big success… but that some people are better at making their own luck with deliberate habits and strategies.
Enjoy the “light” reading!
Weekend reading for June 23rd – 24th:
It’s Official: DoL Fiduciary Rule Is Dead (Mark Schoeff, Investment News) – For over 3 months since the 5th Circuit Court of Appeals issued its controversial decision to vacate the Department of Labor’s fiduciary rule on the premise that the DoL overextended its reach by trying to regulate not only advisors but non-advisor brokerage salespeople, the court has finally issued its official mandate that makes the decision effective and formally vacates the rule (along with ordering the Department of Labor to pay the industry’s legal costs for the appeal itself). The mandate had been expected on May 7th, a week after the deadline passed for the Department of Labor (via the Department of Justice) to appeal the ruling, and especially after attempts by both AARP and state attorney generals to intervene and appeal were also rejected. When the final mandate didn’t come for several weeks, rumors abounded about whether it was because the court was waiting to see if the Department of Justice would appeal directly to the Supreme Court (which they did not do by the June 13th deadline), or whether the judges internal to the 5th Circuit were weighing the possibility of an internal review of the decision. Now, however, the final issuance of the mandate really, truly puts the issue permanently to rest: the Department of Labor’s fiduciary rule is vacated, and the focus will now shift entirely to the SEC’s own newly proposed advice rule to subject brokers to a (non-fiduciary) “Best Interest” standard instead.
Merrill Lynch Considers Lifting Ban On Commission-Based Retirement Accounts (Lisa Beilfuss, Wall Street Journal) – Within days of the official passing of the deadline for the Department of Labor to make its final appeal to the Supreme Court, making the final mandate to vacate the DoL fiduciary rule all but inevitable, Merrill Lynch announced that it was “reviewing” its prior 2016 decision to ban commissions in retirement accounts that was implemented when the fiduciary rule was first about to take effect. The about-face is notable not only for the potential reintroduction of commissions itself, but because in 2016 Merrill launched a media campaign advertising its then-new policy to ban commissions and commitment to a (less conflicted fee-based) fiduciary duty to retirees. However, it appears that Merrill’s shift may be occurring in part because some clients themselves were unhappy about the change to eliminate commission-based retirement accounts, with buy-and-hold investors who traded infrequently expressing dissatisfaction about being moving into what would have been a more expensive fee-based account, or being forced to shift to the cheaper online-only Merrill Edge solution. Accordingly, Merrill is reportedly looking over the next 60 days at loosening the restrictions specifically around individual stock and bond transactions, and private equity investments, inside of retirement accounts, for clients where it would actually be in their best interests to remain commission-based and transactional and who want the ability to engage in one-off stock transactions (and just pay a transaction fee trading commission) in their retirement accounts. Similarly, JP Morgan’s private banking business was also reported this past week as stating that it would “remove the shackles” on commission-based accounts in the wake of the DoL fiduciary rule’s demise. On the other hand, it’s notable that a shift to exclusively fee-based accounts was never actually a requirement of the DoL fiduciary rule in the first place, but a policy position that Merrill Lynch and other firms decided to take on themselves (potentially simply because of the long-term financial stability of the AUM over transactional model), and Merrill still notes that it doesn’t anticipate many investors taking advantage of the opportunity to flip back to a commission-based account.
Supreme Court Curbs SEC Judges, Backs ‘Buckets Of Money’ Adviser (Greg Stohr, Bloomberg) – The case of Lucia v. SEC was nominally about whether investment adviser Ray Lucia provided misleading information in his “Buckets of Money” retirement strategy seminars by backtesting his strategies with inflation rates that did not reflect the actual historical rates of inflation for the simulated time periods, for which Lucia was ultimately fined $300,000 and barred from the investment industry. However, given that the Lucia ruling in 2013 was handed down by an SEC-internally-appointed Administrative Law Judges (ALJ), Lucia appealed on the basis that the judge should have been viewed as an “officer of the United States” and therefore must be appointed to that position by the President or other officers with sufficient authority, and that the SEC’s ALJs were not empowered to issue the rulings they did. The SEC defended the approach, claiming that ALJs only needed to be employees of the SEC, because their final rulings are still reviewed by SEC Commissioners (who themselves are appointed by the President). And after initially losing on appeal in the United States Court of Appeals in a split decision, Lucia appealed all the way to the Supreme Court… which this week ruled in his favor, stating that the ALJs should have been treated as officers of the United States given their judicial power, and therefore should have been appointed by the President (or a delegated officer) directly, not internally as SEC employees. Notably, the Trump administration had already previously announced its own shift in view, favoring the approach that ALJs should be appointed (and not hired as employees) and siding with Lucia, and the SEC had already changed its process of hiring ALJs prior to the final Supreme Court ruling. Nonetheless, the ruling raises questions for over 100 cases currently underway at the SEC where ALJs are involved, and a dozen others that are already on appeal regarding the issue, and may impact other government agencies that also use Administrative Law Judges (including the FDIC and the BCFP). From the industry perspective, the good news of the change is that many viewed the internally-selected ALJs to have a bias in favor of their employer (the SEC), for which a shift to appointed judges may provide a potentially more objective and unbiased ruling; the bad news is that it may lead to greater cost and time to defend SEC investigations that go to court, as one of the appeals of the ALJ system was its expedited lower cost.
Next Stop For Mutual-Fund Fees: Zero (William Birdthistle & Daniel Hemel, Wall Street Journal) – In the past 20 years, the average expense ratio of a mutual fund has fallen by more than a third, and for index funds now averages less than 0.1%… raising the question of when or whether the fee will simply go all the way to zero. In fact, the trend has already begun, with Fidelity launching its first-ever “free” index funds in April (i.e., with an expense ratio of zero) as part of its new Flex suite (albeit only in certain fee-based managed accounts, including the Fidelity Go robo-advisor platform, as Fidelity is already being paid an advisory fee directly). And Birdthistle anticipates that the trend towards lower- (or outright zero-)cost will only continue, driven by four key factors: 1) the rising popularity of passive investing as more investors eschew paying an additional layer of fees to active fund managers; 2) the shift to “non-branded” index funds that hold a full basket of market securities but don’t have to pay licensing fees (while the SPDR S&P 500 ETF carries an extra 3bps of fees just to pay S&P for the right to use the name!); 3) the rise of mutual funds generating income from non-expense-ratio sources (e.g., in 2017 the Vanguard Total Stock Market Index recovered more than 63% of its expenses with revenue from securities lending); and 4) free publicity from the firms that break ranks to offer free index funds will help to further reduce costs (as 0.75bps of the SPDR S&P 500 ETF’s expense ratio last year was marketing costs). Of course, the reality is that ultimately, companies must generate revenue and turn a profit somehow; nonetheless, banks are ultimately in the business of paying interests to manage their money (in the form of paying interest on deposits), raising the question of whether the mutual fund industry can be similarly reinvented or disrupted. Or at least, become a “free” layer that underlies the revenue being generated by providing a more valuable layer of real financial advice.
Mutual Funds Feel The Pinch Of Platform Fees (John Waggoner, Investment News) – As the pressure grows on mutual fund managers to cut their fees, the pressure is growing on no-transaction-fee platform providers (e.g., Schwab, Fidelity, and TD Ameritrade) to cut their own fees (or at least clarify what portion of their expense ratio is going to those NTF platform providers for “distribution”). Because the reality is that while NTF platforms have been popular with consumers, there is still a cost – paid by the mutual funds to the platform, and thus ultimately borne by consumers through the fund’s expense ratio, even though they often don’t realize it (and mistakenly assume the fees are going to the mutual fund manager when they’re not). In fact, Schwab, Fidelity, and TD Ameritrade reportedly charge as much as 40bps to be on their “no-load no-transaction fee” platform (between 12b-1 fees and sub-TA fees), though that cost breakdown and the 40bps “wrapper fee” that the platforms are charging is never actually reflected on a client statement. Some fund companies have attempted to switch to offering “clean shares” that don’t pay underlying 12b-1 and/or sub-TA platform fees, especially in the wake of the DoL fiduciary rule, but by and large platforms continue to insist on receiving the back-end payments (thus why TD Ameritrade visibly removed known-to-not-pay-back-end-fees Vanguard funds out of its NTF platform last year). The platforms argue that the servicing fees are necessary to cover the cost of providing administrative and shareholder services, and that fund companies would have to provide them anyway… though arguably, the NTF platforms could simply decide to be transparent, and charge the equivalent wrap fees directly to the consumer (or advisor) as a platform fee instead.
The Personalized Index Fund’s Time May Be Near (Chuck Jaffe, Wall Street Journal) – In recent years, the popularity of indexing has led to a proliferation in the number of “index funds”, as what started out as a way to own broad slices of the market is now coming in increasingly narrow and specific domains, including index ETFs in everything from artificial intelligence (AIEQ) to gaming (GAMR) to obesity (SLIM) and “whatever stuff millennials are into” (MILN). Yet with the rising capabilities of technology tools to manage portfolios, it’s arguably only a matter of time before investors can use the tools to simply create their own personalized, customized index fund instead and eliminate the need for index funds altogether. In essence, the investor could simply specify their own index rules – e.g., “buy all large-cap stocks with a positive earnings trend and no debt on the balance sheet”, and let the software buy (and subsequently rebalance) all the stocks that fit based on those screens or filters. Of course, there may still be some trading costs to buy and sell the securities (although the ever-declining wrap fee for unlimited trading is pulling the cost down every year), and the technology itself may still have some cost (as the software company still needs to generate a profit!), but the advantage is that there would no longer be any management fee to the index fund sponsor to assemble and manage (or pay the cost to license) the construction of the index. On the other hand, not all investors will necessarily want to take the time to create their own rules-based personalized index fund, either; nonetheless, even Morningstar CEO Kunal Kapoor anticipates that at least a subset of Do-It-Yourself investors will increasingly migrate in the direction of personalized funds in the coming years (especially amongst next-generation investors that have shown a preference for personalization in everything they buy).
5 IRA Planning Strategies To Use Now (Ed Slott, Financial Planning) – For most individuals, “tax planning” doesn’t occur until they begin the process to prepare their tax return with an accountant, at a time when it’s already after the close of the tax year and usually too late to engage in many (or any) tax planning strategies. Ideally, tax planning should be done on a forward-looking basis… which is challenging, as this is the first year that investors will be subject to the new Tax Cuts and Jobs Act, for which a substantial number of rules have changed. To get ahead, Slott suggests 5 core IRA planning ideas to focus on (before the end of the 2018 tax year): 1) consider whether any prior year 2017 Roth conversions should be reversed (as while new 2018 conversions are permanent and no longer can be recharacterized, 2017 conversions can still be unwound as late as October of this year), especially if the client’s tax rates have decreased (which would make it appealing to reverse-and-replace the 2017 conversion with a new 2018 conversion at lower rates); 2) plan a Qualified Charitable Distribution if the client is over age 70 1/2, especially with the new higher standard deduction that will make it difficult for many to otherwise qualify for any itemized deduction for charitable giving; 3) begin paying any advisory fees associated with an IRA directly from that IRA to obtain pre-tax treatment (as IRA fees paid with outside dollars are no longer deductible under TCJA); 4) don’t forget the impact of the IRA aggregation rule when calculating the tax consequences of a partial Roth conversion that includes after-tax dollars (including and especially so-called “backdoor Roth” contributions); and 5) don’t forget to review all clients for their current-year RMD obligations, especially those who are just turning age 70 1/2 (and will have to make decisions about their first RMD), and clients who inherited an IRA last year and will have to take their first post-death RMD out of the account by the end of this year!
What The New Tax Law Means For Investment Advisory Fees (Ed Slott, Financial Planning) – One of the more controversial aspects of the new Tax Cuts and Jobs Acts for financial advisors was the elimination of the tax deduction for investment advisory fees, which were not targeted specifically but thrown out along with every other type of “miscellaneous itemized deduction subject to the 2%-of-AGI floor” under TCJA (although technically this was/is a moot point for higher-income investors who were already losing some, most, or all of the deduction previously due to the 2%-of-AGI threshold requirement). Notably, though, commissions are effectively still deductible, either because they are applied directly to the cost basis of the investment and reduce its capital gains or increase its capital losses (e.g., the cost of a trading commission), or because they’re subtracted (pre-tax) directly from the expense ratio in the case of a commission on a mutual fund. Fortunately, it is at least still permitted to pay an investment advisory fee directly from a pre-tax IRA, which itself is a pre-tax account, and therefore makes the advisory fee pre-tax without being treated as a taxable distribution; however, the IRA can only pay its own fees (and not the fees for other non-IRA accounts), and some investors may still prefer the long-term tax-deferred compounding growth of keeping the IRA intact instead (and paying the now-non-deductible fees from an outside account anyway). And in the case of a Roth IRA, investors will definitely want to pay the fees from outside accounts, and not diminish the value of the otherwise-potentially-tax-free Roth growth.
Dodging The State & Local Tax Cap Through Non-Grantor Trusts (Lynnley Browning, Bloomberg) – Popular estate planning attorney Jonathan Blattmachr has developed a new tax technique to avoid the $10,000 cap on the deduction for state and local property taxes; transfer the residence into an LLC, and then split the LLC up into multiple separate Alaska non-grantor trusts (typically created for the benefit of their spouse as a SLAT), each of which will then file their own tax return, and claim their own $10,000 SALT deduction (for a total of $50,000 in deductions across 5 trusts). The move has been gaining popularity in states with high property taxes, and especially those with high income taxes as well (where affluent homeowners may already “cap out” the deduction with their state income tax bill alone, getting $0 of property tax deduction), such as New York, New Jersey, and Connecticut. Of course, setting up multiple non-grantor trusts itself has a cost – which is important, as each trust is still subject to its own SALT cap, which means preserving a full deduction of $50,000 of property taxes requires 5 trusts, and deducting $100,000 in property taxes requires 10 trusts! And the trusts ideally should be established in states that don’t themselves have an income tax (thus why an Alaskan non-grantor trust is popular). However, even with anticipated setup costs of about $20,000, the ability to deduct substantial property taxes can, over time, more than make up for the setup costs (as the ongoing costs to maintain the trusts would be lower and simpler in subsequent years). On the other hand, it’s important to bear in mind that non-grantor trusts are not eligible for the Section 121 exclusion on capital gains when a primary residence is sold, and completing the transfer may be problematic if there’s a substantial mortgage (where the bank may not approve the change in ownership). In addition, there’s also a risk that the IRS could issue guidance to prevent individuals from using multiple trusts to dodge the SALT cap, most likely by collapsing the multiple non-grantor trusts into a single trust if they all have identical grantors and identical beneficiaries… and just to be respected in the first place, the trust must have an “adverse party” to approve distributions (beyond just the grantor’s spouse as beneficiary), and grantors must bear in mind that once transferred, they don’t control the property anymore, because it’s under the control of the trustee.
A Counterintuitive Change To Your Daily Schedule Can Make You Feel Happier And Less Busy (Shana Lebowitz, Business Insider) – For most people who feel too busy, the instinctive response is to remove more things from their calendars (meetings, workouts, etc.) to reduce their number of obligations. But in a recent new book entitled “Off The Clock“, time management expert Laura Vanderkam suggests that a more effective approach is to add appointments to the calendar instead – ones that specifically schedule and protect time with family and friends. The reason is that we have a tendency to expand time to fill whatever meetings or other obligations we have scheduled… which means even if we try to subtract other commitments, new ones will tend to crop up, while actually scheduling time with family and friends forces us to commit to it (and manage around it, and not allow ourselves to just get sucked into browsing the internet or social media with “found” idle time). In fact, Vanderkam suggests that the more deliberate and intentional we are about our family and friends time, the more constructive it is; just as we don’t show up at work at 8AM with no idea what we’ll do until 1PM, we shouldn’t come home at 6PM with no thought of what we’ll do until it’s time to go to sleep at 11PM. Ultimately, the point is not about filling the schedule in a way that may make us feel even more busy, but simply that by “scheduling” time with family and friends, we can be more deliberate about actually maintaining those relationships… which is especially important given recent research based on the Harvard Study of Adult Development that it’s the quality of good relationships with others that keeps us happier and healthier.
Live Like A Hydra (Buster Benson, Medium) – The concept of “antifragile” was popularized in recent years by author Nassim Taleb (in his book by the same name), and is used to describe things that actually benefit from shocks, volatility, randomness, disorder, and/or uncertainty. In other words, it’s not just having resilience to resist shocks; antifragile things get better from shocks, from the mythical Hydra that grew two new heads every time one was cut off, how muscles get stronger when they’re pushed to the point of failure, or how evolution occurs because the randomness of mutations combine with natural selection to allow a species to evolve. Which is important, because a lot of the techniques we use to gain efficiency – like setting goals and creating habits – can also be very fragile and are easily disrupted. In fact, Benson suggests that you should expect the “Chaos Monkey” will knowingly throw a wrench in the works from time to time… and anticipating the impact of the Chaos Monkey will help to figure out better ways to make your life more antifragile. For instance, it becomes especially important to not just build in redundancy and layers (improve resiliency), but to specifically avoid risks that could wipe you out completely (or more generally, avoid things that don’t work, rather than just trying to find the ones that do but might be disrupted by the Chaos Monkey later anyway). Similarly, it’s important to recognize that antifragility isn’t only about being able to survive the shocks, but to benefit from them, or more generally from the good randomness that can occur. Accordingly, an antifragile life should also include room for experimentation and tinker (i.e., “take lots of small risks” because one might turn out disproportionately well), and be able to keep your options open. And to the extent you need rules and systems, focus on creating simple rules and redundant systems, that give you room to adapt to whatever life throws at you.
How To Maximize Serendipity (David Perell) – Serendipity is a term used to describe the occurrence of random events that turn out beneficial. Which is an important phenomenon, given the growing awareness that those who are most successful often also have a lot of luck as well… while recognizing that some people seem to be better than others at “making their own luck” (i.e., making their own serendipitous events) happen. Perell suggests that the starting point to creating more serendipity for yourself is to create a “serendipity vehicle” – a place where it’s easy for people to find you and for opportunity to knock, which in the digital world might be a website, blog, or podcast. Although notably, not all serendipitous connections happen in the digital world alone; facilitating networking connections matter, too, although Perell suggests that the best networking happens indirectly and in situations where there’s time to form a relationship, which is why he prefers to host smaller intimate events, rather than going out to traditional networking meetings. It’s also important to recognize the significance of being healthy, as in this context, eating healthy food and getting enough sleep will leave you more energetic and engaged… and people like to connect with people who are more energetic and engaged! Other tips that Perell suggests include: “zig and zag” (do the uncommon thing to create new possibilities, from traveling to obscure places instead of traditional destinations, or more generally surround yourself with a wide range of people who are different than you); “avoid boring people” (i.e., stay away from people who aren’t interesting, and work on your own conversational skills to avoid being a boring person that others won’t want to spend time with either); dress for the occasion, as the reality is that those who dress too casually are often mistaken for being sloppy or careless, which may be unfair but still means that facilitating serendipity means being dressed sharp enough that you’re ready to capitalize on a serendipitous encounter; maintain “ambient relationships” by having a way to stay top of mind to the people who matter to you (from starting a newsletter to send out, or simply regularly calling, texting, or checking in with people, even briefly); ask for help when you need it, as you may be surprised by how willing others are to help (in ways that you may not have even expected); and don’t be afraid to “Go First” and initiate opportunities yourself, whether it’s talking to your crush, sending that email you’ve been thinking about, or handing out a simple compliment… because the downside is just a sprinkle of embarrassment, but the upside is limitless.
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.