Enjoy the current installment of "weekend reading for financial planners" – this week’s issue starts off with a few regulatory articles, including a discussion of the SEC’s regulatory examination priorities for 2013 – with a special warning to hybrid advisors – and a look at whether RIA firms need to reconsider how they check off the boxes of what services they offer on their From ADVs.
From there, we look at a few practice management and business succession articles, including a look at the HighTower model used to acquire advisory firms, a look at the so-called "valuation gap" between what most advisors think their firms are worth and what a buyer is really willing to pay for them, and a very frank discussion from a veteran advisor who has been through four failed succession planning attempts and can speak first-hand to the problems that arise in the process. We also have two technology-related articles, including a nice recap of the financial planning software panel from the recent Technology Tools for Today (T3) conference, and an industry-star-studded technology trends roundtable from the Journal of Financial Planning.
In additon, there are a couple of retirement planning articles this week, including a look at the top 5 issues in retirement research and policy, a fascinating analysis from Moshe Milevsky showing how the best strategy for variable annuity guaranteed income riders may be to start taking withdrawals immediately (even if the client doesn’t need them!), and an analysis from retirement researcher Wade Pfau on whether we may be over-projecting retirement returns.
We wrap up with two much lighter articles: the first provides a great reminder that a client complaint should be viewed as an opportunity to improve your business for all your clients, and the second provides an important reminder of the value of saying "thank you" from time to time, whether to a boss, co-worker, or especially employee; while offering nice pay and benefits (and a job in the first place) is a great start, don’t underestimate the positive motivating effects of showing simple gratitude, too. Enjoy the reading!
(Editor’s Note: Want to see what I’m reading through the week that didn’t make the cut? Due to popular request, I’ve started a Tumblr page to highlight a longer list of articles that I scan each week that might be of interest.You can follow the Tumblr page here.)
Weekend reading for March 2nd/3rd:
SEC Sets Examination Priorities – This Investment News article highlights the recent release of the SEC’s 2013 Examination Priorities, which highlights areas that the examiners intend to focus on and areas of concern for SEC regulators. Notably highlights include an increased focus on hedge funds and private equity funds after a fresh 2,000 of them recently became registered with the SEC (as a part of Dodd-Frank requirements), how 12(b)-1 fees are being used (especially as they impact distribution agreements between fund companies and broker-dealer or custodial platforms for "shelf space") as well as other payments between fund companies and other companies that may be "payments for distribution in guise." Perhaps most notable – as highlighted earlier in the week on this blog – is the SEC’s announcement that it will also take a greater focus on dual-registered "hybrid" advisors, especially those who maintain a broker-dealer relationship and an outside RIA, to evaluate whether proper oversight and prudence occurs when advisors decide which clients will be given brokerage account products versus investment advisory account solutions.
Checking A Box – In the Journal of Financial Planning, Rick Adkins makes the interesting point that many RIAs may be using their Form ADVs as more of a marketing checklist of what they’d like to offer "Yes, we could do that if you wanted to hire us to try" – rather than an actual statement of what they are currently providing. As a result, a lot of firms may be checking the boxes for services they aren’t really providing, including stating that they offer financial planning services even if that’s rarely (or never?) actually the case. Yet this raises concerns, because ultimately the SEC basically uses those checkboxes as the basis for what services they should be auditing when an examination occurs, and introduces the risk that the firm could be held accountable for something it doesn’t even really do! Adkins notes that unfortunately the guidelines for this are still vague – while the SEC certainly wants things like assets under management, credentials, and compensation to be crystal clear, it’s less certain what their expectations are for services offered, and whether it’s aspirational (we’d like to offer this), positional (we’d like to be perceived as offering this), or real (we routinely do offer this). But what would happen if the SEC ultimately does apply their auditing due diligence to the "we offer financial planning services" checkbox? Would you have a robust, defensible answer to a regulator about what planning software you use and why, which clients have and haven’t received a plan (and provide the SEC a documented copy), and could you articulate to the SEC a monitoring process for your clients’ financial plans (beyond the portfolio) that mirrors the monitoring done for the client’s investment accounts? The ultimate bottom line from Adkins – if financial planning is going to be recognized as a profession, perhaps it’s time a regulator really did ask these kinds of questions and hold advisors who claim they’re doing financial planning to be accountable for their answers.
High Flyin’: Revisiting The Hybrid Model With HighTower – In this Investment Advisor article, Bob Clark takes a look at HighTower Advisors, one of the major financial advisory aggregator firms that has been particularly successful in acquiring breakaway brokers who leave wirehouses and adopt an independent model – and HighTower serves to replace many of the sophisticated tools and solutions that were previously available to the advisors in the process. Here, though, Clark highlights how HighTower structures its relationships with its advisors, and how the deals come together. Clark starts by reviewing the current marketplace for advisory firm acquisitions, noting that many transactions are done on the basis of a multiple of revenues, especially when the buying firm intends to assimilate clients into its existing infrastructure and overhead (which means the profitability of the prior firm isn’t necessarily relevant); although some have criticizing the revenue-multiplier approach (or at least that the amounts were too high), in recent years the revenue multiple approach seems to remain popular and the valuations are even expanding. With HighTower, however, there’s more of a partnership, as successor firm owners may stay around for 10 years, and HighTower tries to drive value for both firms by using its size to negotiate lower overhead costs. Although the deal structure is a bit more complex, it ultimately amounts to an amount close to a whopping 3.5 times gross revenues for firms – paid out with half up front and the remainder over 9 years, to ensure that the firm owners stick around to support the ongoing growth of the enterprise.
What Is Your Advisory Practice Really Worth? – This article by John Furey and Matt Cooper on Wealth Management takes a deep look at the so-called "valuation gap" – the often problematic difference between what advisors think their firms are worth based on industry average statistics (e.g., ~2X revenue), versus what they often turn out to be worth when a willing buyer comes forward with a real offer. The article starts out with an example of an advisory practice with about $125M of AUM, roughly $1M of fees, and an advisor take-home pay of $550,000, which the owner believes is worth $2.2M (based on either 2.2X revenue, or 4X earnings). Yet when digging in further, the caveats emerge: the owner wants the staff to receive employment contracts, but they have no ability to generate new revenue, and the clients are mostly in their 60s and already taking withdrawals. In addition, a significant portion of the advisor’s take-home pay includes money that would have to be paid to a replacement lead advisor, and it’s not even clear that 100% of clients will successfully transition to a new advisor. As a result, the "real" value of the firm might be no more than about half of the advisor’s assumed value. In fact, the authors suggest that this valuation gap is the primary reason that most deals for advisory firms fall through; the businesses just don’t turn out to be as much as the founding owners expect. The second half of the article provides suggestions about how to close the valuation gap and enhance the value of the business, including a systematic effort to make the business not just about the owner, invest in the business and developing quality staff, grow and have a plan for ongoing growth (that doesn’t require the founding owner), start well in advance (so it’s not a hurried fire sale), and try to make the business more efficient or scaled in the first place through bringing in a partner, outsourcing, or both.
What I Learned From Four Failed Attempts To Find A Successor – This RIABiz article tells the interesting story of Dennis Gibb, an advisor with about $400M of AUM and a total of almost $1.1B under advisement (in an apparent niche advising on institutional funds in the Native American community), who has tried and failed four times in nearly two decades of trying to find a successor. The first successor fell through because at the end of the day, he preferred to sit in front of a computer screen trading investments, rather than getting out to see clients and grow the business. The second was a woman who was going to take over the practice and expand its financial planning offering, but she decided at the last minute to go another direction and strike out on her own instead. The third was a former bond trader who would potentially expand the firm’s fixed income offering, but it turned out to be a conflict for the consulting/advisement side of the business and then became very expensive to unwind. The fourth was another woman who apparently decided late in the process that ultimately she was just not comfortable with the risk of the transaction. Given these failures at succession, and that Gibb is now 66 years old, he is deciding that he may simply work until he passes away at this point (what he calls "going the toe-tag route"). He wraps up with a series of conclusions that will likely be controversial but represent his experience, including: men may be better successors than women because men are more entrepreneurial (his words not mine!); typical advisors [at wirehouses] are not as entrepreneurial as they used to be decades ago; the more impressive the business owner is (i.e., the more the business is wrapped around the owner) the harder the succession will be; there are few good succession/exit options for most firms; and watch out for confirmation bias, where you perhaps unwittingly only see what you want to see in a successor and ignore the problems until it’s too late.
Which Financial Planning Software is Right For You? – This blog article from consultant Craig Iskowitz provides a great summary of the financial planning software panel at the recent Technology Tools for Today (T3) conference, which included planning software designers Bob Curtis from MoneyGuidePro, Dr. Linda Strachan from Zywave (NaviPlan), Alex Murguia from inStream Solutions, and Oleg Tishkevich of FinanceLogix. In terms of overall approach, Murguia highlighted inStream’s role in making planners more proactive; Strachan suggested that planning is a balance of art and science, where the planner provides the art and the software supports the science; Tishkevich noted that the future of advice (and software to support it) is mobile; and Curtis notes (later in the article) that software needs to be able to help clients plan and navigate through uncertainty and their fears. The panel came to some disagreements about the importance of simplicity of the software for use, versus the complexity of the planning that is must support, with Strachan emphasizing the requisite complexity and Murguia taking the opposite extreme, stating "if someone has to read our manual, then we made the software too complicated." MoneyGuidePro and FinanceLogix have taken this a step further, providing tools to complete a quick initial and basic plan with a client on the spot, that can then be expanded upon further with subsequent client interaction. Ultimately, the highlight of this article isn’t necessarily the details of the software programs themselves – although there are some important differentiators – but a glimpse into the mind of the leaders driving the development of the software, as different planners will likely be attracted to different software simply based on this perspective alone and how it compares to their own planning philosophy.
Tech Trends And Implications: How Financial Planning Is Adapting – This cover article for the Journal of Financial Planning is a roundtable on technology trends for financial planning and the implications for advisors, featuring tech consulting heavy hitters Bill Winterberg of FPPad, Joel Bruckenstein of T3, Davis Janowski of Investment News, and Spenser Segal of ActiFi. The interview covers a wide range of topics, but highlights include: the biggest trends on the horizon (mobile devices, the cloud, software integration, and the rise of social media); touchscreens that make financial planning a more tactile and interactive experience; whether advisors should focus on iPads, Android devices, or Microsoft surface (general consensus is clients use iPads, but businesses are still built around Microsoft, but Android’s open platform could eventually outgrow them all); the role of custodians and broker-dealers (right now they’re the guardians of the data, but they also help to drive a lot of the innovation and integration); and the potential that in the future there may be no holy grail of software but an open platform of integration where advisors pick and choose the best-in-class solutions that fit their needs.
Top 5 Retirement Issues – This cover story from the March issue of Investment Advisor magazine interviews five notable experts and influencers in the world of retirement research and policy about what they see as the biggest issues confronting today’s current and prospective retirees and how they’re served by the financial services world. Phyllis Borzi from the Department of Labor highlights the coming fiduciary rule for employer retirements plans – with a potential "controversial" provision that may extend DOL fiduciary rules to rollover IRAs as well – and others weigh in about the industry implications of this change. Barbara Roper of the Consumer Federation of American expresses concerns about the annuity landscape – particularly the complex variable annuities with living benefit riders and equity-indexed annuities that may be too difficult for most consumers to understand (she even notes that not all agents selling such products entirely understand them, either!). John Carl of the retirement learning center suggests it’s time for Washington to better support retirement incentives (e.g., wider access to private pension plans outside of employers) and notes that some states are innovating on solutions faster than Washington. Matt Greenwald is focused on Social Security and Medicare reform and solutions, although he notes that Social Security is actually "easy to fix" and that Medicare and its rising costs is the real challenge. Michael Finke suggests that better retirement income advice needs to be developed, and that the 4% rule is a "historical anomaly" and that solutions should include more immediate and longevity annuities for guaranteed lifetime income.
Milevsky’s VA Shocker: Turn on Your Living Benefit, Now – In this article for Research Magazine, retirement academic Moshe Milevsky tackles the interesting question of what to do with existing variable annuities that have retirement income living benefit riders that are no longer available in today’s marketplace – should clients actually add dollars to the contract (if possible) to lock in more dollars with the "old" guarantees but subjected to the associated costs, or keep the money separate… and if clients do have an old guarantee, when should they activate it? The surprising conclusion after extensive number-crunching by Milevsky and his colleagues: not only is it a bad idea to add money, but the best thing to do is actually to start drawing income on the guarantee as soon as possible. Even if the money isn’t needed, it can just be allocated to another savings account instead (or 1035 exchanged to a low-cost annuity on a tax-deferred basis); the fundamental goal is actually to deplete the contract as quickly as possible, trying to trigger the income guarantee – in large part, because the fees stop when the cash value is depleted (even if it’s just been extracted to be invested elsewhere) but the income guarantee continues! While this notably means that the client will not likely get many/any future step-ups in the income guarantee, that’s ok – by Milevsky’s math, it’s actually a red herring, as the potential boost isn’t worthwhile enough given the cost drag and the potential to deplete the contract and activate the guarantee sooner! Of course, the clear caveat is to take withdrawals within the rules and constraints of the guarantee; if you take withdrawals too fast and violate the constraints of the rider, you can ruin the guarantee itself and defeat the whole point of the exercise! (Note: For further reading, see Milevsky’s full research paper analysis on SSRN.)
Compound Interest And Wealth Accumulation: It’s Not As Easy as You Think – On his blog, retirement researcher Wade Pfau takes an interesting look at long-term investment return assumptions, after reading of the 8% long-term portfolio assumption used by Ramit Sethi in his popular "I Will Teach You To Be Rich" book. Pfau starts by noting that the long-term average return on markets is about 11.8% on equities and 5.5% on bonds, based on the Ibbotson yearbook since 1926. However, these are nominal returns, which investors ultimately need real returns for future spending; on a real basis, these numbers come down to about 8.6% for equities and 2.6% for bonds. From there, Pfau points out that Ibbotson returns are actually arithmetic returns, and that the returns are lower when measuring the actual compounded growth rate after volatility; this brings the returns down to 6.5% real for equities and 2.3% for bonds. Of course, most investors will hold a balanced portfolio, so the combined return might come down further – for instance, a 50/50 portfolio of these assets would be a long-term real return of about 3.9%. Yet Pfau points out that even this amount is probably too high for forward-looking projections, given that today’s bond yields are nowhere near the levels that produce typical historical returns, and the low real return on bonds drags down the expected real return on stocks as well (even assuming we still get the historical risk premium). What does this ultimately amount to for clients and their retirement projections? Adjusted for today’s environment, Pfau concludes with a 2% real return on a balanced portfolio, and notes that investors who are still relying on 8% (nominal) may be sorely disappointed and if they are saving on this basis will find themselves far short of their retirement goals when the time comes. Of course, most planners have already been accounting for inflation in their long-term projections (by adjusting future retirement expenses up for inflation, instead of adjusting returns down, which accomplishes the same goal), but Pfau still makes an important point that returns going forward from here may be lower than historical levels given the current real return environment.
Turn Your Toughest Customer Into Your Biggest Fan – From Inc magazine, this article provides some nice tips about how to turn a difficult customer/client situation into a positive – which is especially important in a service-oriented business like financial planning. The first key is to thank your client for a complaint when it occurs, and mean it – a complaint is a genuine opportunity to take input and improve your business, and you should be thankful for the information! At the same time, make sure you soothe yourself, too – angry customers can make us emotional, too, and it’s hard to respond properly and effectively if you’re losing control of your own focus – and recognize that you need to get comfortable with conflict, so you can be ready to take the high road and avoid pointing fingers or passing blame or making excuses. You can help get yourself through this by being certain to mentally frame issues in a positive light – a difficult customer is not a reason to pull your hair out, but an opportunity to practice and hone your skills while gathering input about how to improve your business for all clients – and you’ll also find yourself more open to the feedback if you try to frame clients in a positive light as well (you’ll take the feedback differently if you think of the client’s comments as "willing to say what’s on her mind" rather than "rude"!). And in the end, be prepared to make things right, but don’t overestimate what it takes, either – a simple question "How can I set things right and make you happy" sometimes takes far less than you actually expect, especially once the client feels heard about the concern.
How To Give A Meaningful "Thank You" – From the Harvard Business Review, this article provides a nice reminder about the importance of saying thank you – in the context of thanking your employees or co-workers (or even a boss who goes the extra mile for you!), for the great work they do. While you might be rewarding employees well with money and benefits – and a job itself in today’s difficult economic environment – it’s still important not to forget the powerful relationship-building and motivating that comes from simple and direct acknowledgement and thanks, and the prosocial behavior it encourages in the office. So how do you give a meaningful "thank you"? Thank the person for something they specifically did that was above the call of duty, acknowledge to them the effort that they made in doing it, and tell them what it meant to you personally. And if you find an unexpectedly shocked or emotional response, recognize that your gratitude might have even been a bit overdue, so be more thankful going forward as well and try not to take those relationships for granted as much in the future!
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!