Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the news that major ETF providers have been establishing and expanding their lines of credit to prepare for a possible liquidity squeeze that could emerge in a market crisis, where a sell-off could force ETF redemptions that would be difficult to fund if/when the underlying securities are illiquid (e.g., with many types of bond and other fixed-income ETFs, as well as emerging markets). The news accentuates the warnings from some pundits, who have cautioned against the risks of owning “liquid” ETFs that are wrapped around otherwise illiquid securities.
From there, we have a few practice management articles this week, particularly focused around succession and continuity planning for advisory firms, including: a look at the key provisions to watch for in establishing a continuity agreement with another advisory firm that would take over in the event of death or disability; a discussion of the key succession planning issues firms should consider if the SEC adopts a succession/continuity planning requirement similar to the recent NASAA Model Rule on Succession Planning for state-registered investment advisers; how advisory firm owners can regain that “new business” feeling if they’ve otherwise lost their energy and focus in the practice; and whether there may be a quiet “demographics tsunami” still lurking as the average age of advisory firm owners approaches age 62 and more and more consider potential retirement.
We also have a couple more technical articles this week, from a look at some research suggesting that baby boomers may not actually be so far behind in retirement after all (once you consider their ability to spend less and save more as kids finally leave the home), to a discussion of the benefits of variable retirement spending strategies that “smooth” the spending in volatile years. There’s also an article on how Medicare Part B and Part D premiums will be increased in 2018 for certain higher income individuals, and a discussion of a new type of long-term care insurance policy from John Hancock that will use “flex credits” to create a kind of LTC coverage that is “participating” similar to dividend-paying whole life insurance.
We wrap up with three interesting articles: the first examines the history of 401(k) plans and how they have evolved from a supplemental retirement plan to one of the key foundational pillars of retirement, which raises the question of whether the current structure of 401(k) plans is still “right” as such a widespread solution; the second article looks at how the SEC has become increasingly gridlocked over the past decade as the five SEC commissioners have become increasingly partisan; and the last is a story about “10 Young Advisors To Watch”, highlighting the inspiring stories of 10 up-and-coming advisors who show how much talent there is in today’s emerging next generation financial planner.
And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end, including a recent Investor Alert from the SEC about the risks of “Automated Investment Tools” (i.e., robo-advisors), the latest efforts of Envestnet to build its “Advisor Now” platform, and a review of the buzz from this week’s Finovate Spring 2015 conference!
Enjoy the reading!
Weekend reading for May 16th/17th:
ETF Companies Boost Bank Credit Lines Amid Liquidity Concern (Ashley Lau & Michael Flaherty, Reuters) – According to recent public filings, major ETF providers including Vanguard, Guggenheim Investments, and First Trust, have been lining up new bank guarantees or expanding ones they already have, bolstering their credit lines for cash to tap in the event of a market meltdown. The focus appears to be on fixed income ETFs in particular, many of which track less liquid bond markets (e.g., high-yield corporate bonds or bank loans) that could face a liquidity squeeze in the event of another financial crisis. And the problem may be worsened by the fact that banks have been shedding their bond inventories due to certain Dodd-Frank reforms, which means the underlying bond markets may have less liquidity in the first place. In other words, if there is another financial crisis and a wave of selling, and ETF providers cannot match sellers to buyers and therefore must redeem the underlying ETF securities to cover the liquidations, there may be a liquidity mismatch where the ETFs are more liquid than the underlying bonds used to redeem them. In turn, this could exacerbate a sell-off into an illiquid market, but the fund companies will aim to combat this by using their lines of credit to cover the redemption requests and avoid selling illiquid bonds into an illiquid market. While hopefully the supporting liquidity efforts of the fund companies will succeed, the effort does raise another cautionary flag about the liquidity risks when the underlying securities of an ETF are less liquid than the ETF itself (and similarly, BlackRock has arranged a line of credit for its less liquid emerging market stock ETFs, and others have established lines of credit for their senior loan ETFs). In the meantime, the Reuters article also notes that providing for these lines of credit to manage potential liquidity risks does itself have a cost, which will likely be borne by the ETF holders in the form of a higher expense ratio for affected funds.
Advisors: How To Plan For The Worst (Kevin Feehily, Financial Planning) – Most advisors don’t want to think about what happens if there is an accident and the advisor is unable to work for a period of time, but the reality is that such “continuity planning” is becoming a hot topic, both for the sake of ensuring continuity of care for clients, and also for the advisor or family members to retain/harvest the value of the business (and avoid a potential firesale that could adversely impact the sale price). Notably, a continuity agreement is different than a succession plan; the latter is about transitioning leadership and ownership of the firm with a proactive plan over time, while a continuity agreement is meant to facilitate a takeover of the business in the event of an unexpected transition. To meet the need, a growing number of “continuity partners” are beginning to emerge – firms like Focus Financial Partners and our own Pinnacle Advisor Solutions – who are willing to sign a continuity agreement that they will step in to take over the practice in the event of death or disability of the advisor, ensuring continuity of service for clients and providing some form of payout for the advisor. Key factors to consider in a continuity agreement include: trigger events (under what conditions is the agreement triggered, especially in the context of situations like temporary disabilities); valuation (how will payments from the buyer to the seller be determined); financing mechanism (how will the continuity partner pay for the practice, and will there be any life or disability buyout insurance involved?); nondisclosure and nonsolicitation clauses (to protect privacy of clients and the interests of the firm until/unless a transition event does occur); and spousal consent ( to help ensure the spouse is aware of the plan and ready to cooperate with the execution, should that time ever come).
5 Key Issues For A Succession Plan (Tom Giachetti, Investment Advisor) – In recent statements, SEC Chairwoman Mary Jo White has indicated that the SEC may soon move to implement requirements for RIAs to have a succession and continuity plan in the event of the advisor’s death or disability (following on a similar Succession Planning Model Rule implemented by NASAA last month). Of course, there’s no “one size fits all” solution for continuity and succession planning, and regulatory requirements are likely to be flexible, but key issues that a plan will likely need to consider include: it should cover both planned (succession) and unplanned (continuity) scenarios; it must consider the tax implications given the type of entity (e.g., the tax treatment may vary depending on whether the business is a C corp vs S corp vs LLC or sole proprietorship, as well as how payments are structured between an entity purchase, asset purchase, earn-out, etc.); have a successor or continuity partner identified who can take over the actual client relationships and service them; have some kind of formula for valuing the business (including recognizing the potential client attrition that may occur if the advisor has suddenly passed away and clients may or may not like the new/replacement advisor); and be cognizant of regulatory constraints (e.g., within a broker-dealer environment, the requirements of the broker-dealer must also be considered).
Getting Back That ‘New Business’ Feeling (Angie Herbers, Investment Advisor) – When first launching a new business, there is a feeling a “brilliance” where we find ourselves in a mental state that enables us to do some of our best thinking and work. The problem, however, is that over time, it’s hard to sustain that ‘new business’ feeling, as the long hours, constant pressures, and continual challenges of running a business begin to take their toll. Herbers suggests that these growing challenges in the firm all stem from one core problem: that over time, the advisory firm changes, and firm owners who keep trying to run their business as they did in the past will become increasingly unhappy by failing to keep up with the current realities of the business. In other words, a business generating $100k of revenues needs to be run differently than one generating $250k/year, which in turn is different than one with $500k of revenue, and so forth. For instance, by $750k/year of revenue, you may have 2-3 staff members, and find that you’re spending far more time than you ever did before trying to train them; by $1M/year of revenue, you have a junior advisor who needs to be trained as well. Of course, because every advisory firm grows differently, the solution won’t always be the same, but Herbers suggests that there are a series of core questions to consider, that will light the path going forward. The first is simply to decide if you really want to grow – really want to, with all the challenges, efforts, and continued sacrifice that goes with it. Second, recognize that if you want to grow, you are probably the bottleneck in your firm, and that you’ll have to change yourself going forward, given that the business is no longer what it once was (due to the growth and change that have already happened). In recognizing all of this, Herbers suggests that ultimately the goal is to treat your current business as though it’s something fresh and new – your biggest experiment yet, something entirely new and different from the past, and something that you can feel energized in trying to build going forward from here, realizing that you’ll make some mistakes along the way, but that’s just part of the growing process.
The Hidden Tsunami (Mark Hurley, Financial Advisor) – When a tsunami forms in the deep ocean, there is only a small wave visible… until/unless it crashes onto a shore. In a similar vein, Hurley suggests that over the past decade, a demographic tsunami wave of potential retiring advisors has been forming – as the average age of advisory firm founders is now 62! – and while the age tsunami is also barely visible so far, it will soon become evident as it crashes onto the shore. Of course, Hurley notes that for many (or even most) advisory firm owners, they will ultimately just “fly their businesses into the ground” – or at least, ride off with them into the sunset – allowing the practice to attrition over time without ever implementing a succession plan or selling the business, and this “plan” may explain why there have been so few public advisory firm transactions. Accordingly, the building tsunami wave may never actually become evident, as an extraordinary number of the firms looking to sell may never actually find a deal that comes to fruition anyway. Yet the momentum seems to be building, as many advisory firm deal-makers – as well as the bankers who finance them – are reporting that the pipeline of potential deals has never been fuller, and that given a sale transaction often takes 18-24 months to come to fruition, an explosion of transactions may be coming soon, though the benefits of these deals are likely to accrue to a small number of acquirers who are best positioned to finance and execute when the time comes.
Are Retirees Falling Short? Reconciling the Conflicting Evidence (Alicia Munnell & Matthew Rutledge & Anthony Webb, Center for Retirement Research) – A great deal of research in recent years has focused on how prepared today’s working-age households are for their future retirement, and the outcomes have been decidedly mixed; some, like the Survey of Consumer Finances and other studies using target income replacement rates, suggest a widespread shortfall, while others using a life-cycle model of optimal savings conclude that most pre-retirees actually have an optimal level of current wealth and are mostly on track. Notably, though, the difference in projected outcomes is heavily reliant on the underlying assumptions about spending and savings behavior. In particular, the life-cycle model assumes up front that those in their mid-career stages will not be saving much, due to the fact that they’re raising children and preparing to send them to college, and accordingly assumes that spending will fall (and that savings will jump) once the nest is empty as the kids leave the house. In other words, a large swath of those in their 30s, 40s, and even 50s may actually be right on track for retirement, because their personal spending without kids is actually much lower than their income implies (which means they don’t need as much to retire), and their ability to save may “jump” in the final stretch before retirement (as child-rearing expenses fall away). These models also suggest that spending will decline in the later years of retirement (a finding increasingly supported by a number of studies). By contrast, studies showing a more widespread shortfall assume steady income replacement rate goals for workers of any/all age, and do not make assumptions about rising/declining expenses around children, nor around declining spending in the later years of retirement. Accordingly, then, the potential gap – or not – in retirement readiness may ultimately be a function of how accurate the life-cycle model really is in capturing consumer spending and savings decisions around the time that kids leave the house. Or at a minimum, makes the point that retirement may at least be more within reach than other studies have suggested, if households really can step up their savings as the kids move out, and don’t just replace that spending with other spending-and-not-savings behavior!
The Best Approach To Adjustable Retirement Withdrawals (Joe Tomlinson, Advisor Perspectives) – While it may be appealing to plan to adjust spending in retirement to deal with the vagaries of the markets, the challenge in doing so is that variable spending strategies can cause retirement spending to vary a lot, possibly to the point of being disruptive. Thus, for instance, a simple approach like just spending X% of your portfolio every year will never run out of money – because if the portfolio declines, so too do the withdrawals – but not everyone may be prepared to cut their spending by 20% or more in a single year just because the market fell sharply that year. Accordingly, many variable spending strategies try to at least “smooth” the adjustments; for instance, the Guyton approach limits the magnitude of adjustments in any particular year, though a recent paper by economist Laurence Siegel suggests that it’s better to smooth the volatility by just owning a less volatile portfolio (i.e., investing less in stocks), rather than trying to smooth the spending itself. The concern that Siegel raises is that a smoothing approach – which does not immediately cut spending by the full amount of portfolio volatility – could extend overspending too far with a portfolio that has declined too much. However, when Tomlinson tests this approach – just owning a more conservative portfolio without smoothing, versus a more aggressive portfolio with smoothed spending adjustments – he finds that strategies which smooth consumption (whether a smoothing overlay on top of the Siegel approach, or adoption of the Guyton approach) are actually more effective at producing stable income than just owning a much more conservative portfolio, producing superior outcomes when measured by economic utility.
Medicare Part B Premiums Increasing Up To 30% (Robert Klein, Marketwatch) – Congress recently passed the Medicare Access and CHIP Reauthorization Act of 2015, which once signed by President Obama will replace the current physician Medicare reimbursement schedule for the next five years (the so-called Medicare “doc fix”), and the change is being financed by higher Medicare Part B premiums for certain higher income individuals. Specifically, the new rules will change Medicare’s Income-Related Monthly Adjustment Amount (IRMAA) for individuals with Adjusted Gross Income (AGI) between $133,500 and $214,000 (or married couples earning $267,000 to $428,000), boosting the additional premium increase by as much as 30%. Going forward, anyone with income above $160,000 (or married couples over $320,000) will face the top Medicare Part B premium rate, now at $4,028.40 per person. Notably, because the IRMAA rules also impact Medicare Part D premiums, those in the affected income range will see Part D premiums rise as well, by a smaller dollar amount but a larger percentage (as much as 61%). And because the income thresholds are not indexed for inflation, they will increasingly impact more and more clients over time as well. The new rules will first take effect in 2018.
The New Long Term Care Policy Design? (Mark Maurer, LinkedIn) – For years, long-term care insurance companies marketed the fact that although it was possible, they had never raised rates on any existing policies. But after years of low interest rates, lower-than-assumed lapse rates, and rising claims experience, companies eventually had no choice but to raise rates, and unfortunately when the dam finally burst the subsequent premium increases were significant and led to a challenging decision-making process of whether to keep the policy at all. Insurance companies have now responded by raising premiums on new policies as well, which has actually reduced the risk of even more future premium increases, but made coverage so expensive that few can afford it (or at least few are willing to pay for it) in the first place. To address this, Maurer notes that John Hancock has recently introduced a new form of long-term care insurance – one where premiums are assumed to increase annually, but one that also provides “flex credits” that can be used in the future to cover LTC expenses during the elimination period, provide a return of premium upon surrender, or to reduce ongoing premiums. In essence, these LTC flex credits operate similar to the dividends of a participating whole life policy – to the extent that the company’s policies perform better than expected (whether due to lower claims, higher lapse rates, or simply rising interest rates that improve the health of long-term care insurance companies), the ‘excess’ premiums are returned as a dividend (or flex credit) in the future. Though notably, the uncertainty of dividends also creates challenges in trying to illustrate these new flex-credit LTC policies – as with other types of participating insurance, “over-projecting” appealing dividends rates may make the policy look less expensive, but those dividends are not guaranteed and may be far less (or in the extreme, nothing at all) in the future. Still, with moderately favorable performance, the flex credits can accumulate to the point in 20-30 years that the otherwise-rising premiums of the new John Hancock LTCI policy could flatten or even begin to decline, and Hancock is going “all in” with this new policy type, which will be the only one it offers going forward (once approval is completed across all 50 states).
A Brief History of 401(k)s (John Rekenthaler, Morningstar) – Section 401(k) of the Internal Revenue Code was created in 1978, established primarily for the purpose of eliminating some uncertainty about the preferential tax status of profit-sharing plan after debate in the early 1970s about whether such favorable treatment should be allowed at all. It was only after the fact that someone realized that the provisions of Section 401(k), which facilitated employees choosing whether to receive profit sharing from an employer as either a cash bonus or a contribution to a retirement plan, could actually be used to allow employees to deduct money from each paycheck into a tax-preferenced retirement plan, “regardless of whether the firm turned a profit”. And to the extent that such plans would be used, they were assumed to simply be supplemental – as the whole profit-sharing retirement plan at the time was option and not commonly used in the first place – and employees would have the choice about whether to participate. Accordingly, there was little focus early on to creating structures like automatic enrollment into 401(k) plans, or a careful selection of default funds; because, again, early on they were only intended to be optional, voluntary, and supplemental. Accordingly, it wasn’t necessarily a problem that only a subset of employees participated, because the 401(k) plan was not meant to be a pillar of retirement at the time. It was only by the 1990s that a trend was emerging for employers to slough off their pension responsibilities and offer 401(k) plans not as a supplement but an alternative, and at that point the importance of driving 401(k) enrollment and participation became a more significant societal problem – where finding a way to “nudge” the bottom 30%, who were rarely participating in (voluntarily) employer retirement plans, became increasingly important, and thus came the path of automatic enrollment (and default investment options like target date funds to go with it) as a part of the (ironically named in this context) Pension Protection Act of 2006. Accordingly, Rekenthaler notes how far 401(k) plans have really come; what in the 1980s was a structure to encourage additional savings and turn more people into investors is now morphing into a structure to default people into savings, support them to save more (e.g., with auto-increase savings programs), and prevent them from doing their own investing (giving them reasonable default investment options instead). Though ultimately, while the latter changes have improved the outcomes, Rekenthaler makes the point that as a pillar for societal retirement savings, 401(k) plans still have a ways to go, shedding some ‘vestiges’ of the original 1978 legislation, and especially to support the still-fractured-and-problematic small employer 401(k) marketplace in particular.
How Partisan Politics Have Poisoned The SEC (Mark Schoeff, Investment News) – Historically, disagreements amongst the SEC’s five voting commission members were usually sorted out behind the scenes, and were often just pertaining to the technical vagaries of rulemaking. But over the past decade, the SEC itself has become increasingly partisan and polarized, and its structure – which always includes two Democrats, two Republicans, and a chair(wo)man nominated by the incumbent president – seems to have now ‘ensured’ a series of 3-2 votes that consistently fall on classic partisan lines (and since the chair is appointed by the president, the tiebreaker generally always comes out to favor whichever party is in the White House). Though the problem is not merely that the votes are consistently split along partisan lines, but that the chronic disagreement is making it harder to get anything done in the SEC, and that close votes can even hurt the SEC’s credibility when its actions are challenged in court and dissenting commissioners are cited as a reason to strike a rule down. And in fact, the SEC’s losses in multiple lawsuits challenging its rules, in part because of its split votes, in turn has slowed down the SEC’s rulemaking progress even further, as now the organization seems fearful to issue controversial rules that even greater risk of being struck down. The partisanship of the SEC also appears further exacerbated by the evolution in who is selected as a commissioner, with a growing number of former politicians who come to the SEC straight from Capitol Hill, and may be even more ‘hard-wired’ towards partisanship – which has particularly compounded the problem of implementing rules under Dodd-Frank (including a uniform fiduciary standard for advisors), which itself was implemented under a very partisan vote from Congress. Though notably, with the recently announced resignation of (Republican) commissioner Gallagher, along with the looming expiration of (Democratic) commissioner Aguilar next month, there are some hopes that the SEC’s gridlock may soon improve.
10 Young Advisors To Watch (Eric Rasmussen, Financial Advisor) – Only 11% of advisors at RIAs are under the age of 35, but Rasmussen suggests that what the next generation of advisors lacks in numbers they make up for with quality. Accordingly, this article highlights 10 up-and-coming “younger” advisors, including: Sophia Bera of Gen Y Planning, who started out of college as an actress, then shifted into personal finance, and now operates a virtual financial planning firm working with people in their 20s and 30s; Meghan Pinchuk, who shifted into financial planning from being an English major at UCLA, and just 9 years into her career is now the co-president of Morton Capital Management, an RIA with $1.5B of AUM; Laurie Belew, who started down a road of business consulting with Arthur Andersen, got away just in time, and is now a partner at FJY Financial, a $450M AUM firm and a former president of FPA NexGen; Alan Moore, who after struggling with paraplanner mismatches in his first two jobs, decided to launch his own standalone RIA at age 25 serving his peers in their 20s and 30s, and two years later co-founded XY Planning Network to help other advisors follow the same path; Dennis Moore, who came through the Texas Tech financial planning program, and now at the age of 34 is the COO of Quest Capital, a $1B AUM firm in Dallas (and also the president of his local FPA chapter); Lisa Brown, who learned early on to work with high-net-worth executives, now has a growing niche with ex-Coca-Cola employees (she’s written two white papers on the subject of retiring from the company and navigating its severance and other benefits), and became a partner at $1.1B AUM advisory firm Brightworth after just 5 years there; Amanda Lott, an early math whiz at RegentAtlantic who now handles 70 clients with an average of over $2M AUM each despite being ‘only’ 28; Jude Boudreaux, who came from a financially distressed childhood to land in financial services and ultimately launched his own advisory firm served his peers using a creative annual retainer system based on income and net worth (since most of his young clients don’t have assets to manage); Tim Maurer, who started out in financial services sales positions, attracted by the money, but has now shifted to focusing on the “personal” aspects of personal finance, having become a radio co-host in Baltimore, a blogger, speaker, and author of The Ultimate Financial Plan: Balancing Your Life and Money; and Eddie Kramer, an up-and-coming advisor with Abacus Planning Group in South Carolina, who not only has a personal client base of high-net-worth clients at the age of 32, but runs the firm’s business development team.
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!