Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with a new industry study from Fidelity, finding that the looming Department of Labor fiduciary rule isn’t just stressing out broker-dealers, but is making RIA firms nervous too, as more and more wonder exactly what the new burdens of compliance will be, and whether new investments in technology will be necessary to bridge the gap. At the same time, also in the news this week was a fresh warning from FINRA that it is beginning to scrutinize how firms are adopting “robo-advisor” tools, pointing out that automated technology doesn’t eliminate a firm’s due diligence obligations to understand the algorithms being used, how solutions are recommended, and whether they are really suitable for the investor.
From there, we have several practice management articles this week, including: a look at the different types of advisor leadership styles, which matters more and more as an advisory firm grows and the role of the founder shifts from advisor and business developer to true CEO and leader; a discussion of the recent regulatory change that some RIAs are no longer required to issue annual privacy notices to clients (but why it’s so easy to do they should continue to provide them anyway); a look at the new Investopedia Advisor Insights platform that aims to pair financial advisors up to answer consumer questions (and whether it is really likely to generate any business for advisors or not); and a handy checklist of what you should have in the “introductory package” of marketing materials that you provide to prospects and centers of influence.
We also have a couple of technical articles this week, from a discussion of which clients will be impacted by the coming changes to Social Security claiming strategies (with the first deadline kicking in on April 29th), to an analysis of how the line of credit is calculated for a reverse mortgage (and why it’s better to establish one sooner rather than later, especially if you think interest rates will rise), and also a look at how the way advisors are using Monte Carlo analysis may be inappropriately biasing the results in an overly favorable manner (by failing to consider the potential sampling error of using historical data in the first place).
We wrap up with three interesting articles: the first raises the question of whether the real robo-advisor “unicorn” (a startup that achieves a $1B valuation) may not be the popular startups of Wealthfront or Betterment, but the lesser-discussed Acorns that may has a paltry $73.6M of AUM but is currently on track for a whopping 2 million users by the end of 2016; the second looks at the popular “mandatory arbitration” clause in advisory firm agreements, and raises the question about whether this is really a valid consumer protection (or in the case of an RIA, an outright breach of fiduciary duty but not allowing clients at least the option to go to court); and the last is a look at how, even as critics suggest the Department of Labor has acted “too fast” in its fiduciary proposal, the movement towards a fiduciary duty for financial advisors is actually a global phenomenon, already enacted in the U.K. and Australia, and pending in Canada, for which the current fiduciary proposals in the U.S. are actually “mild” by comparison (which in turn suggests that the DoL’s fiduciary rulemaking may just be the beginning of the changes to come!).
Enjoy the “light” reading!
Weekend reading for March 19th/20th:
Fidelity Study Says Half Of RIAs Foresee Negative Business Impact Due To DOL Fiduciary Rule (Greg Iacurci, Investment News) – Fidelity recently asked financial advisors for their views about the looming Department of Labor fiduciary rule and how it may impact them, and the survey results show that while the DoL rule is viewed as primarily targeting broker-dealers, the RIA community is concerned as well. Notwithstanding the fact that RIA firms are already held to a fiduciary standard, 55% of RIAs still anticipate increased time for compliance-related tasks and/or training as a part of the new rule, and 40% anticipate there will be an overall increase in the cost of doing business as an advisor. Of course, given the rule’s likely impact on brokers and commissions, a much larger number of broker-dealer based advisors (a whopping 77%) are concerned about the rule’s impact on their business. As a result, 66% of advisors reported that they plan to re-evaluate products they recommend, with 28% saying they will likely use variable annuities less often, and 26% saying they’d recommend alternative investments less frequently. However, given that the final rule hasn’t even been announced yet, the study also reported that the majority of advisors are still waiting to take any action until they actually see the final rule.
FINRA Vows Keen Oversight of Digital Advice Tools (Suleman Din, Financial Planning) – This week, FINRA issued a new report intended to provide a “firm reminder” to broker-dealers that deploying robo-advisor and “digital investment advice” technology doesn’t change the firm’s fundamental obligations for compliance and oversight. Firms would still be expected to govern and supervise the algorithms used in digital advice tools, and the portfolios being presented to users/clients, not to mention giving careful consideration to how they’re evaluating client risk tolerance in the first place (especially if no human advisor is involved, and given that some robo-advisors ask as few of just four questions to determine a suitable portfolio allocation). The new FINRA focus comes just as an increasing number of broker-dealer firms are looking to adopt “robo-advisor” tools, and a recent industry study from Cerulli suggested that trend will only continue with the looming DoL fiduciary rule. Nonetheless, the FINRA report implies that at a minimum, firms will need to perform serious due diligence on their digital advice and “robo” tools to assess and monitor that the solutions being implemented are truly appropriate, including any potential conflicts of interest embedded in how the robo-advisor selects its investments (e.g., where the robo-advisor’s own proprietary funds are used), as well as how rebalancing is done.
Leadership 101: What’s Your Advisory Style? (Angie Herbers, Investment Advisor) – It’s a fundamental challenge for most growing financial advisors that eventually, their success will depend more on their employees than their own interactions with clients. In turn, this means the founding advisor’s role will shift from being the main advisor and revenue generator of the firm, to the CEO that leads other advisors and revenue generators (and everyone else, too). That being said, not everyone will have the same management or leadership style, which is ok, because there are many different ways to lead successfully. Herbers notes four common types: the Visionaries who see opportunities that other people haven’t and create businesses to fill that need (and notably, while many advisors had the ‘vision’ to start their own business, just building an advisory firm [often similar to many others] means you’re an entrepreneur, but not necessarily a true visionary); the Operators who are action-oriented, focused on getting things done and leading by example (who do well in smaller firms that require their constant energy); the Processors who value routine, trust data over hunches, and can turn their consistency into a real strength for the business (and comforting to employees, who know exactly what to expect, and what is expected of them); and the Synergist, who is a “people’s person” with a high degree of emotional intelligence and a skillset for building strong relationships and navigating group dynamics. Notably, while some aspects of emotional intelligence and being a “synergist” can be learned, Herbers points out that most of these leadership styles represent a natural inclination of the leader, which means your best path is not to try to make yourself fit one or the other, but simply to recognize which one you are and try to focus on playing to your strength.
Investopedia’s Grand Scheme For RIAs To Act As Its Answer Army (Lisa Shidler, RIABiz) – This week, Investopedia launched its new “Advisor Insights” solution, a Q&A service that allows consumers who have questions beyond Investpedia’s core encyclopedia-style definitions to ask an advisor directly… with the hopes that some of those consumers may then move forward to actually work with the advisor. Yet while Investopedia’s volume of traffic is certainly impressively – reportedly a whopping 20,000,000 monthly readers – the caveat is that it’s not clear whether people asking for quick answers online are really going to be interested in then following through to engage that advisor for more comprehensive services. And in fact, Investopedia CEO David Siegel is “quick” to say that he isn’t going to promise that the site will match up advisors and clients… simply that advisors will be read by thousands of investors, and that the service is about “helping advisors get their name out in a meaningful way.” Still, Investopedia wants to be certain that the advisors on the platform are of reasonable quality – and therefore vets their advisors by checking their regulatory records first – and currently doesn’t even charge advisors to participate (there are no subscription fees or pay-to-play). In addition, moderators will oversee both the questions themselves – ensuring ‘reasonable’ finance-relevant questions – and the responses, to ensure advisors are not just responding by trying to sell products or be overly promotional. (Of course, the more that advisors are limited in the responses they give, the more risk there is that advisors simply give away free content to Investopedia with no realistic chance of developing any new business on the platform!)
How To Create An Effective Introductory Packet (Teresa Riccobuono, Advisor Perspectives) – An “introductory packet” is a packaged set of marketing materials that an advisor can hand to a prospective client (or perhaps a center of influence) to provide key information on the firm and what it does. Riccobuono provides a good checklist of the key elements to include in your intro package, including: business cards (include three – one for each spouse of a couple, and a third they can hand out to someone else); information on how the prospect should prepare for the initial meeting (what they should bring, how long it will take, directions to your office); a menu of your services; your mission/value proposition for clients and what they can expect from you (e.g., your annual client service calendar); a brochure for your parent company (if applicable); a brochure about CFP certification (available directly from the CFP Board); and a copy of your clean U-4 (given the increasing recognition of why a clear conduct history should matter to consumers!). Last, be certain to include a thorough bio about yourself, as the person the clients will be working with. And since the reality is that people do business with people they know, like, and trust, making yourself a person that prospects can connect with and relate to is important, so in addition to just including details of your work history and credentials and awards/honors, give more personal information as well, including perhaps where you grew up, and your sports or other hobbies and activities. Be certain to be specific about the details too – because those are the direct points of connection upon which conversation and a relationship can form!
What The 2016 Social Security Changes Mean (Amanda Lott, Financial Advisor) – Last November, President Obama signed into law the Bipartian Budget Act of 2015, which enacted significant changes to several popular Social Security claiming strategies: file-and-suspend, and restricted application. The latter, which allows someone to claim a spousal benefit at full retirement age while delaying his/her own benefits until later, will now only be available to those who were born in 1953 or earlier. In the case of file-and-suspend, which was used to activate spousal or dependent child benefits while allowing the original worker’s benefit to continue to earn delayed retirement credits, will no longer be available starting on April 30th of this year. Notably, those who are widowed or already collecting are not impacted by the new rules, and divorced clients (who didn’t remarried) are not impacted by the new rules if they were born in 1953 or earlier. However, married couples who have not yet claimed benefits may be impacted, particularly if they planned to coordinate between spousal and individual benefits and have not already begun their benefits (and/or were not eligible to). For those who will not be full retirement age 66 by the end of April, they will also be impacted – in that file-and-suspend will simply no longer be available anymore at all. But even with the file-and-suspend and restricted application strategies gone, Lott notes that coordinating the timing of Social Security claiming amongst couples will still matter. There may just be slightly fewer combinations and choices to consider. In the meantime, stay tuned for more potential changes to Social Security in the future, since these crackdowns actually produced minimal chance to Social Security’s long-term fiscal health, which still faces an approximately-20% shortfall by 2034.
Understanding The Line Of Credit Growth For A Reverse Mortgage (Wade Pfau, Journal of Financial Planning) – While reverse mortgages have long had a bad reputation with financial planners (and the public), a growing base of research is suggesting that they should be considered as a potential tool for retirement planning. One of the more popular strategies that is emerging is to use a reverse mortgage line of credit as a contingent reserve to supplement retirement income, which notably finds that the best approach is to establish the line of credit earlier rather than later (even if it won’t be used for years or decades). The reason it’s better to start a reverse mortgage line of credit early is because of how it grows over time – because with a reverse mortgage, the effective interest rate of the loan (a combination of the one-month LIBOR rate, the lender’s margin, and a fixed mortgage insurance premium of 1.25%) applies not only to the outstanding balance on the loan, but also the maximum line of credit that is available. Of course, if the retiree uses the line of credit immediately, the growth in the maximum amount will simply move in line with the outstanding balance on the loan. However, if a retiree establishes the line of credit early but doesn’t use it, there is no balance upon which any loan interest will accrue, and the maximum line of credit will compound higher along the way, providing even more of a line of credit against which the retiree can borrow later if necessary. In fact, Pfau shows that the available line of credit for a retiree who starts early and borrows later may be dramatically higher than the retiree who simply waits to establish the line of credit later. In addition, because the maximum line of credit available will increase with interest rates (since the effective rate is calculated based on one-month LIBOR), the reality is that any future increase in interest rates will only make even more of a line of credit available for retirees in the future, should they need it. (In fact, Pfau suggests that the benefit may be so significant, that at some point the government may even intervene and limit the benefit for new reverse mortgages in the future.)
Why Monte Carlo Analysis is Optimistically Biased (James Lear, Advisor Perspectives) – While the common criticism of Monte Carlo analysis is that it fails to account for the possibility of “black swan” or fat tail events, Lear suggests another problem with Monte Carlo analysis: that when advisors input their assumptions for average returns and standard deviations based on historical data, they are failing to adjust for the reality that the historical data is just an “estimate” for what returns and volatility are likely to be, not a true known quantity. When adjusting for the possibility of sampling error, the potential range of Monte Carlo outcomes become even more diverse, which means there is more of a danger than the client could have a catastrophic shortfall, in turn implying that the Monte Carlo analysis is “optimistically biased” and that the prospective retiree should be saving more (or spending less) to defend against the uncertainty. Fortunately, such a bias is reduced by using longer historical data series to generate the estimates, and is less pronounced when forward-projecting over shorter time periods (i.e., the bias is more pronounced when projecting 60 years for a 30-year-old than projecting just 20 years for an already-retired client). Nonetheless, Lear notes that any methodology that “just” looks at historical averages and fails to consider the risk of sampling error will inherently overstate the certainty of Monte Carlo results to at least some degree.
Why Acorns is the Only Roboadvisor That Could Be Worth $1 Billion (Craig Iskowitz, Wealth Management Today) – While the media hype over the past year has focused on startup robo-advisors like Wealthfront and Betterment, versus established companies like Schwab and Vanguard launching their own initiatives, Iskowitz suggests that the biggest “robo-advisor” story may be a lesser-known company called Acorns. For those unfamiliar, Acorns is a mobile app that lets users link their bank and/or credit card and automatically round up the cost of their regular consumer purchases to the nearest dollar, with the spare change allocated to the Acorns platform to be invested into a portfolio of ETFs. From an AUM perspective, Acorns isn’t having much traction yet, with a paltry $73.6M of AUM at the end of 2015 (while both Wealthfront and Betterment have crossed $3B of AUM in the past few months). However, from a user perspective, the picture is quite different – Wealthfront has barely 35,000 accounts, while Betterment is over 100,000 accounts, and Acorns is over 750,000 accounts, growing 57% in just the past two months alone as the company begins to launch internationally (suggesting the company could have over 2,000,000 accounts by the end of 2016). The significance of this user growth is that it means even if the AUM growth is slow so far, it’s pricing model of $1/month per user could still add up to material revenue (compared to other robo-advisors), and Acorns could rapidly accelerate growth further thanks to the sheer volume of investors, by opening the door to additional services that could generate additional revenue in the future (e.g., recommendations on term insurance or credit cards, as Mint.com does). And notably, Acorns is operating with “only” 77 employees (far fewer than most other robo-advisor competitors), suggesting the company is much better positioned financially to keep fighting and growing in the long run.
Should Fiduciary Advisers Swear Off Mandatory Arbitration? (Norb Vonnegut, Wall Street Journal) – It is a brokerage industry standard that when clients open up an investment account, included amongst the paperwork is a requirement that the client gives up any right to sue the broker in court or a trial by jury, in exchange for agreeing to mandatory arbitration instead for any dispute that may arise. Of course, defenders of arbitration point out that in theory, arbitration can be similar to going to court anyway, and is simply faster, cheaper, and less complex than litigation. However, Vonnegut points out that if arbitration is better for most clients, they could simply be given the choice for arbitration and decide at the time. Why the requirement? Is it because the broker-dealers believe that the FINRA arbitration process may be biased in their favor? And even more concerning, why is it that according to one recent industry survey, even registered investment advisors (in Massachusetts) are used a predispute mandatory arbitration clause in their paperwork? Is that really a mechanism for putting client interests first, or simply a protective mechanism for the firm to avoid the risk of a jury trial, even if the client perhaps deserved their day in court?
DOL’s Fiduciary Rule Changes Part Of International Movement (Karen DeMasters, Financial Advisor) – While there has been a lot of buzz about the Department of Labor’s fiduciary proposal, including extensive criticism from anti-fiduciary opponents that the DoL has been moving “too fast”, the reality is that considerations of the fiduciary rule here in the U.S. are just part of an ongoing international movement to reform financial advice. For instance, the United Kingdom revised its fiduciary rule in 2013, and was even more ‘extreme’, as it outlawed commissions entirely (not just subjecting them to a best-interests contract) and required more transparency, not just for retirement plan advisors but all advisors. Similarly, Australia also issued fiduciary rule revisions in recent years, and changes are under way in Canada as well. What all of this suggests is that not only is the DoL’s action “right on time”, it is arguably still relatively “minor” compared to the more significant fiduciary changes happening elsewhere. In turn, this also provides further support for the idea that the fiduciary changes may not end with the DoL rule, and that there will be continued pressure on the SEC and FINRA to follow through and apply fiduciary rules more broadly and uniformly to all advisors, as has been done in other countries. On the other hand, looking at the recent fiduciary changes in other countries also provides more guidance about the potential fallout here in the U.S., which has included a 25% decline in the number of advisors in the U.K. (with most of the decline coming from bank-affiliated advisors who left the business once they could no longer sell the bank’s proprietary products for a commission), and a boon to financial technology as firms look to get more efficient and some consumers are shifting to online platforms now that there are no more hidden commissions and they recognize how much advisors are actually being paid.
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.