Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the latest news about the case between the CFP Board and the Camardas, with the latter filing a new motion in court to compel the CFP Board to move forward in the discovery process as the Camardas claim the CFP Board has failed to provide information in a timely manner. Separately, there’s also an article that provides an interesting profile of the recent activities of Nick Schorsch, the non-traded REIT magnate who in the span of one year has exploded onto the advisor scene, aggregating together almost half a dozen different broker-dealers to quickly form what is now one of the largest B-D networks in the country.
From there, we have a trio of technical financial planning articles this week, including a look at the White House’s recent suggestion that it may be time to curtail the File and Suspend Social Security strategy for wealthy couples (though doing so will require an act of Congress, so nothing changes are imminent), the rising use of Health Savings Accounts (HSAs) as a form of “Medical IRA” for more affluent clients, and an important cautionary note regarding no-lapse guaranteed universal life policies where some clients are finding that their guarantees are being forfeited not by paying premiums too late but by actually paying them too early instead!
We also have several practice management articles this week, including a provocative article from Mark Tibergien suggesting that perhaps it’s time for the advisory world to spend less time talking about succession planning and more time focused on people development and cultivating the next generation of advisors instead, a look from Angie Herbers at the importance of creating an internal leadership team to begin cultivating your next generation of advisors and firm leaders, a review of a recent aRIA white paper on how to enhance the value of your advisory firm, and a good discussion of the 40-40-20 rule in evaluating and benchmarking the profitability of your advisory firm (and identifying what to change to ‘fix’ low profit margins).
We wrap up with three interesting articles on the theme of the rise of the robo-advisor: the first looks is from Bob Veres, and looks at how robo-advisors are commoditizing investment management and may ultimately lead to a bifurcation of advisory fees (a low AUM fee paired with a separate planning retainer); the second is from Angie Herbers, and cautions advisors not to become too enamored with the scalability of investment management and forget the importance of doing financial planning for clients to attract and retain them; and the last is from HighTower CEO Elliot Weissbluth suggesting that in the end the “robo-advisors” will not obliterate human advisors but will eliminate all the “posers” (those “advisors” who don’t really add value with their financial advice and are just trying to sell investment products instead) which will actually make room for the “real” advisors to be even more successful!
And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end! Enjoy the reading!
Weekend reading for March 29th/30th:
Camardas Ask Court to Force CFP Board’s Hand – Last week, Jeff and Kim Camarda filed a new motion against the CFP Board to compel them to move forward in providing discovery documents for the ongoing lawsuit. In early February, the CFP Board had indicated that it would take about a month to produce the requested documents – after a judge in January struck down a series of motions the CFP Board had filed to narrow the discovery request – but as of March 15th, the CFP Board still had not delivered any of the information. The CFP Board indicates that it is still working on providing the information, but at this point has not responded to requests from the Camardas to establish a deadline. Once the information is provided, the case will move forward to gathering depositions from key parties (presumably with a trial still anticipated later this year or sometime next year).
What’s Next For Nick Schorsch? – This cover story from Financial Advisor magazine is an interesting profile of Nick Schorsch. Up until little more than a year ago, most advisors had never heard of Nick Schorsch unless they were active sellers of his non-traded REIT offering American Realty Capital. However, in 2013 a string of acquisition deals mean that Schorsch now runs one of the largest independent broker-dealers in the country, as his purchases of Cetera Financial Group, J.P. Turner, First Allied Securities, Investors Capital Holdings, and Summit Financial Services, have led him to quickly be in charge of more than 9,000 advisors and about $200B of collective client AUM (and some expect Schorsch may add even more deals in 2014). From the broad perspective, the goal appears to be consolidating a large number of ‘smaller’ broker-dealers, trying to acquire economies of scale with efficiencies around anything from clearing to technology to vendor contracts (for instance, LPL is more profitable than many competitors for this reason), and perhaps ultimately exiting the company with an IPO or private sale. And the Schorsch empire may extend beyond “just” aggregating broker-dealers, and also pairing together an investment banking option, research, and trading capabilities as well. Some have suggested, though, that Schorsch may simply be trying to “buy distribution” – i.e., to gather up broker-dealers that can sell his non-traded REITs and other affiliated/proprietary financial services products (especially in the alternatives category), though given that Scorsch’s firm already sold $9B of REITs just last year, it’s not clear that they “need” the distribution. Whatever the path ultimately turns out to be, the clear focus this year will just be on integrating together all of the different broker-dealer firms and the acquisitions that have been made; but the bottom line is that given the sheer size and scale of the acquisitions already, Schorsch’s firm is a significant player in the industry, with a lot of eyes watching and wondering what will happen next.
‘File-And-Suspend’: A Social Security Strategy Under Fire – Last month, the White House released their 2015 budget, with an important line item that mentioned changing the rules to go after the wealth for “aggressive” moves to “manipulate” their Social Security claiming decision. Although it hasn’t been publicly elaborated on, White House officials speaking on background have indicated that the target is the File-And-Suspend Social Security claiming strategy for couples, specifically wealthy couples. Although anyone can use it, the concern is that it’s being used disproportionately by wealthy couples (and financial advisors guiding them to do it!) and imposing an additional cost on the Social Security program. However, there’s limited data to quantify the real cost at this point, and one study by the Center for Retirement Research suggests that only 46% of file-and-suspend benefits are flowing to the top 40% of households; in addition, overall the strategy appears to still be a relatively small phenomenon, at least so far. The strategy is completely legal – in fact, it was specifically created under President Clinton as a part of the Senior Citizens’ Freedom to Work Act – but the White House seems interested in “nipping it in the bud.” Notably, a change to the File and Suspend rules would require an act of Congress, so don’t expect any actual change in the immediate future; nonetheless, given the White House’s more aggressive stance on the strategy, there is still at least some risk that its days are numbered.
HSA Strategy: Create a ‘Medical IRA’– When the Affordable Care Act was implemented, there was some concern that the popularity of Health Savings Accounts (HSAs) would begin to lag; however, so far HSAs appear to be thriving, and HSA-compliant health insurance plans account for nearly 20% of the offerings on the new health exchanges (compared to only about 7% HSA market share in employer-sponsored health insurance). The appeal of HSAs is not just that the contributions are tax-deductible, and that payments for qualified health care costs are tax-free (without any income limits or phaseouts); nonqualified distributions are taxable and also subject to a 20% penalty, but notably beyond age 65 the 20% penalty is waived (though nonqualified distributions over age 65 are still taxable). This in turn is leading some clients to use HSAs as a form of “medical IRA” where clients who are healthy without ongoing medical expenses can buy a high-deductible health plan, claim a tax deduction for maximum funding for an HSA, and then simply use the funds in the future for retirement expenses (where the pre-tax treatment going in and ordinary income treatment coming out, with no penalties, makes the HSA just like any pre-tax IRA in retirement). Right now, most HSAs are simply funded with liquid funds (e.g., cash equivalents), but HSAs are portable and can be transferred to an HSA provider with a broader menu of investment choices once the HSA grows large enough that it makes sense to do so.
Problems With Universal Life Guaranteed (ULG) Premiums? – From life insurance expert Peter Katt, this article notes an interesting but concerning issue with today’s Universal Life Guaranteed (ULG) policies (sometimes also known as No-Lapse Guarantee or NLG policies). The idea of ULG policies is pretty straightforward – for a certain premium, the policy will maintain a death benefit for life, even if the cash value performs poorly and the policy otherwise runs out of money. In order to maintain the guarantee, though, the policy premium has to be paid consistently every year. The problem that has arisen is in some cases, if a policyowner pays the premium too early, it is credited to the ledger in the prior year instead of the current year, which can result in a shortening or potential lapse of the guarantee even though the proper dollar amounts were paid. In one case that Katt observed, the problem cropped up because the premium was paid a mere two days too early and changing the guarantee from lifetime to one that would only last until age 100. Contacting the insurance company did ultimately resolve the issue, but only because it was caught by the advisor and pursued in the first place. The bottom line: unless a ULG policy has been funded by a single premium that truly guarantees it for life, be certain to regularly monitor the no-lapse guarantees on such policies, even if the client is apparently paying premiums as they are scheduled.
How Does This Movie End? – In this month’s Investment Advisor magazine practice management guru Mark Tibergien makes the case that the time has come to shift the industry’s focus on succession planning towards the more productive endeavor of “people development” instead. Tibergien suggests that all the talk about succession planning is actually leading advisors to go into denial and avoid the issue altogether (with an astonishing number of advisors having no succession plan at all, even at ‘advanced’ ages), especially given that many advisors aren’t emotionally or financially ready to retire anyway. So if many/most advisors really aren’t ready to leave their practices anyway – for a variety of reasons – Tibergien suggests that it would be more productive (both for their firms, and the professional overall) for them to focus on developing people instead, figuring out how to attract and retain young people into the business, educate them and develop new advisors – who, later, may become the successors that so many advisors are looking for anyway. But the bottom line is that the succession planning conversation is moot without a younger generation to fuel it, and so many advisors aren’t really ready to leave anyway, so perhaps it’s time for us collectively to focus on a more productive endeavor instead?
Leadership Teams Put the Success in Succession – Continuing the theme from the prior article, practice management consultant Angie Herbers makes the key point that owner-advisors today considering succession planning are spending too much time focusing on the value of their business and how the successors will pay for it, and not enough about actually grooming those successors to be the leaders that are capable of buying and running the practice in the future. In fact, Herbers estimates that the “numbers” portion of the succession plan (and all the fancy spreadsheets that support them) makes up only about 5% of a successful succession plan, and the other 95% is about the successors themselves: the younger advisors who eventually need to be capable of driving the growth of the firm and making management decisions. Of course, advisors can try to hire an experienced advisor with a management track record to run the firm, but Herbers cautions that such individuals are very rare and very expensive (and often already tied up in the succession plan of their current firm!). As a result, most firm owners will want/need to groom their own successors, and Herbers suggests the best way to do this is to create an internal leadership program – a team that discusses the firm’s current challenges, tries to come up with solutions, and then engages those members in the specific projects to address the challenges. Herbers suggests a rigorous structure to the meetings, with a clear agenda and set time schedule – as key employees who won’t respect the team rules will be demonstrating that they aren’t ready to be leaders – but at the same time, be certain that participation is encouraged from everyone, as some employees not used to the role may be too deferential and need to be encouraged to take on more of a leadership mantle.
5 Concrete Ways to Boost Your Firm’s Value – A recent white paper from aRIA entitled “Turning Your Practice into a Business: Creating Profitable, Manageable & Sustainable Enterprise Value” found five key areas in which advisors can focus to increase the value of the firm. The first step is to simply assess the value of the firm – i.e., with a formal valuation – as many advisors who may be earning a good income in their businesses may not even realize how much (or how little) value has really been created until they go through the process. The second key step is to “lock in” key employees who have important roles within the firm (which could even be an advisor’s assistant who has important connections and relationships with key clients), either by giving them bonuses (in ‘smaller’ firms) or by offering them equity stakes (for ‘larger’ firms over $2M of revenue). The third key is to “decide to delegate” by figuring out exactly what the advisor does best that no one else can, and then assign the rest of the work to others (hiring up as necessary in order to do so). The fourth key area is to create a team model – generally including a relationship manager, a financial planner, and a client services representative, supported by a centralized asset management team – which allows the firm to ensure a more consistent client experience. The last key area is for the firm to emphasize profits, as the study suggests that owners tend to focus too much on assets and revenues, and often fail to determine the true profitability of the firm – which, notably, should include the cost of paying another advisor to do their own job if they were gone.
What Advisors Get Wrong About Firm Profits – This article makes the fundamental point that in evaluating an advisory firm, it’s really crucial to look at net profits, not just revenue and AUM. For instance, a $50M AUM firm with a 1% fee and a 20% profit margin would actually be more valuable than a firm with twice the AUM and 40% more revenue but only a 10% profit margin. Overall, the driver of a firm’s enterprise value is really three key levers: current profitability (after all compensation, including appropriate salaries for owners themselves), sources of (profit) growth, and the sustainability of the profits. So how can you evaluate your own firm’s profitability? The article advocates the 40-40-20 rule (often discussed by Mark Tibergien and covered in his seminal book on the subject for advisors), where ideally your advisor compensation should be approximately 40% of your gross revenue, your overhead expenses should be another 40%, which leaves you a 20% profit margin (notably, this entails breaking owner compensation into separate categories for how they’re paid as an advisor for their work in the business, and their profits as owner of the business). So what should you do if your firm doesn’t match the 40-40-20 rule and your profitability is low? Look carefully at your fee levels overall (are you charging enough? are you discounting too much for key clients?), and your costs in the various categories (including an allocation for your own salary), and begin to consider adjustments once you see which numbers are “off” from the benchmarks.
‘Robo Advisors’? How to Fight Back – In this article from Financial Planning, industry commentator sets out his own vision of the future of financial planning and how the rise of the “robo-advisors” will impact financial planners in the coming decade. At the core, Veres suggests that these offerings will “finish the job of commoditizing the asset management side” of the advisor business/revenue model; not that they’ll necessarily do a better job, per se, but they will do it at a very low cost, and likely continue to criticize the breadth of active managers that fail to consistently outperform the market (along with the advisors who recommend them). This doesn’t mean that advisors will die away, but it does mean that advisors will have to increasingly really focus on the delivery of advice, rather than portfolio management. The key distinction is that while advisors may do “everything the robo-advisors do and more” to justify why their fees are 1% and a robo-advisor is only 0.25%, Veres suggests that eventually this is going to lead to a formal bifurcation of fees, where advisors too will start to chart 0.25% for the asset management work, and a retainer fee for the planning work (even if it’s still paid from the portfolio). In turn, this will bring a renewed focus on one of the weak points in the advisory world: how to determine a fair price for the work that advisors do, charge appropriately according to complexity, and even shift from large upfront fees to alternatives like smoothed monthly retainer fees.
Thinking of Cutting Back on Financial Planning? Don’t. – This article by Angie Herbers shares an experience she had when, tasked by a business professor, she investigated the economic value of offering financial planning as a part of an asset management firm… and came to the conclusion that from the numbers alone, it’s highly undesirable. While asset management is hugely scalable (you can manage $1B almost as efficiently as $2B), financial planning is labor intensive and time consuming, so much so that it’s hard to justify when solely looking at the income statement of the business. Yet Herbers notes that ultimately, a successful business must be able to retain existing clients, and attract new ones, and financial planning is highly impactful for both, as it strengthens client relationships (which improves retention), takes the focus off investment performance (which further improves retention), and helping clients succeed financially and lead happy lives can go far in attracting new clients (as referrals from happy existing clients) as well. Thus, as Herbers views it from a business perspective, financial planning functions as a “loss leader” for a wealth management firm, and while it may be difficult to consistently charge for it on a standalone basis, it has a tremendous impact on making asset management businesses more stable and ultimately more profitable and valuable (even and perhaps especially if it isn’t priced separately).
State of Financial Services: Embrace the Big Bang or Face Extinction – This article, from HighTower CEO Elliot Weissbluth, looks at what he calls the emerging “big bang” disruption of financial services: the era of the robo-advisors, which seem likely to be embraced by the Millenials (also known as Generation Y), the first generation of “true digital natives” who have also indicated they are very distrustful of traditional offerings from the financial services industry. Weissbluth notes that the threat today is still limited, but will rise as the Millenials enter their prime investing years in the future, and demand financial services companies that honor their key values: transparency, innovation, and unlimited access. Notably, though, Weissbluth doesn’t see this trend as one that will obliterate the need for human financial advisors; instead, the disruption will expose the industry’s “mediocre advisors”, and once the “posers” are out of the way, skilled and experienced advisors will be at an even greater premium than they are today, because the reality is that “complex situations require on-going collaboration and engagement.” The bottom line regarding the future of financial services: it will involve “a combination of the best of both worlds: the ease and simplicity of technology, coupled with the skilled and holistic human touch.”
I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd’s Eye View – including Weekend Reading – directly to your email!
In the meantime, if you’re interested in more news and information regarding advisor technology I’d highly recommend checking out Bill Winterberg’s “FPPad” blog on technology for advisors. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read “FPPad Bits And Bytes” on his blog!