Weekend Reading For Financial Planners (May 23-24)

Author: Adam Van Deusen, CFP

Team Kitces

Adam is a Financial Planning Nerd at Kitces.com. He previously worked at a financial planning firm in Bethesda, Maryland, and as a journalist covering the banking and insurance industries. Outside of work, he serves as a volunteer financial planner and class instructor for local and national non-profits.

Read more of Adam’s articles here.

Investors Largely Fine With Advisor AI Use For (Internal) Admin Tasks, More Skeptical Of Automated (External) Communications

(Grace Williams | FinancialPlanning)

The increased attention being paid to Artificial Intelligence (AI) technologies has generated a range of opinions from the public, from those who are excited about the possibilities for making work and personal tasks more efficient, to those who are skeptical about its accuracy and alignment with its users' interests. These feelings might come to the forefront when it comes to financial advice, given the sensitive nature of personal finances for many individuals, suggesting that advisors' use of AI might come under scrutiny from prospects and clients alike.

According to a survey of 1,000 U.S. investors with at least $250,000 investible assets by Janus Henderson Investors, 79% said they would be upset if their advisor used AI and didn't mention it to them, suggesting that disclosure at the least should be a top priority for advisors incorporating AI into their practices. However, only 33% of respondents said their advisor has discussed how they use AI in their practice, suggesting a potential disconnect and source of frustration for clients who find out that their advisor is actually using AI (particularly if it involves the client's data).

Notably, respondents' views of AI varied by the task being performed. For instance, while only 12% of those surveyed said they would be upset if their advisor used AI to create educational content and 13% would be upset if they used it for internal administrative tasks, 33% said they would be upset about advisor AI use for providing investment recommendations and 40% would be upset about their advisor using AI to automatically respond to the investor's texts or emails. Which is in line with Kitces Research last fall that similarly found advisors themselves are least interested in using AI to automate direct client service interactions, instead preferring AI for more internal uses.

Also, while there has been speculation about investors shifting to AI-powered advice tools and away from human-provided advice, the AI "trust penalty" appears to remain a factor, with 75% of respondents saying that the potential for AI recommendations to be biased or conflicted is a barrier to using the technology for investment decision making, while 74% have concerns about data privacy or security as well. Further emphasizing that from the client perspective, AI is better used for administrative tasks than client service or outright advice recommendations based on their (private and personal) data.

In the end, while some advisors might be eager to adopt AI tools, given the sensitive nature of the topic of AI and client data, at least being open with clients about how the firm is incorporating AI (and perhaps seeking input on the types of tools clients would be comfortable with?) can help to build trust, and prevent potential client 'surprises' that could nudge them to look for a new advisor.

Single Americans Financially Confident, But Estate Planning Is Key Weak Spot: Survey

(Michael Fischer | ThinkAdvisor)

While clients often approach an advisor as a couple, there are many types of potential single clients as well, from those who are divorced or widowed to those who never married in the first place. While single clients share many of the same goals as their married counterparts, they also bring unique planning issues to the table, particularly when it comes to estate and long-term care planning.

According to a survey of 3,000 single U.S. adults with average investable assets of more than $700,000 sponsored by Ameriprise, 85% of respondents report feeling financially confident in their current financial situation and see themselves spending more on social and entertainment activities, lifestyle enhancements, and travel compared to others. The 52% of respondents who work with a financial advisor appear to benefit from the relationship, with 81% of this group reporting that advice has increased their financial confidence and 72% reporting that their advisor helps them translate long-term goals into concrete plans.

That said, 43% of those surveyed report fearing that they will run out of savings, with 42% concerned about affording long-term care, 41% worried about becoming a financial burden on others. Further, many of these individuals also appear to lack insurance coverages that might be particularly valuable to singles, with only 34% having disability coverage (which is notable because they wouldn't have a spouse's income to rely on in case of a disability) and 29% having long-term care coverage (which could also be valuable given that they wouldn't have a spouse to care for them, though some might turn to children or others). Also, many of these solo adults haven't established key estate planning documents, with only 37% having a formal will, 41% having a health care directive and 38% having a financial power of attorney.

Altogether, while many solo individuals might crave the independence that comes with navigating life (and their finances) on their own, financial advisors appear to be able to play a helpful role for those in this group, from serving as a sounding board for financial goals and plans to ensuring that they maintain key insurance coverages and have prepared estate planning documents that can help ensure they continue to thrive through retirement and leave the legacy they desire.

Donors Largely Have Altruistic Motivations For Charitable Giving, While Advisors Are Well-Positioned To Boost Efficiency Of Gifts

(Steve Randall | InvestmentNews)

When it comes to supporting clients through planning around charitable giving, financial advisors' focus is sometimes on helping clients complete gifts in the most tax-efficient way possible (e.g., through a Donor-Advised Fund [DAF], Qualified Charitable Distributions, or through gifts of appreciated investments). However, at a more basic level, advisors can also support clients in translating their charitable intent into gifts that match their preferred causes.

According to a survey of 1,003 donors sponsored by fundraising software firm Bloomerang, 96% of respondents said wanting to make a difference motivates their charitable activity, with financial considerations playing a secondary role, suggesting that leading with the tax implications of different ways to give could mean skipping over clients' primary motivations for giving. Also, 94% of donors said they are more likely to act when they know precisely where their contribution will be directed (suggesting that they are willing to get into the details of a donation, rather than just giving to an organization more generally).

Also, while older individuals might be assumed to give more (perhaps due to having greater wealth), there appears to be surge in charitable interest amongst Millennials, with 75% of respondents in this generation saying they expect to increase their giving this year (compared to 49% of those in Gen X and 36% of Baby Boomers). Millennials were also significantly more likely to use a DAF than those in older generations.

In sum, charitable giving can be a key financial goal for many clients and one that provides a sense of meaning commensurate with other types of spending. Which suggests that for advisors seeking to work with philanthropically minded clients, going beyond the tax implications of different ways to give and helping maximize both the size and impact of their gifts could ultimately lead to greater client satisfaction (and, indirectly, magnify the advisor's positive impact on the community!).

Using "Omega" To Maximize Retired Clients' Spending Utility

(William Bernstein and Edward McQuarrie | Advisor Perspectives)

When it comes to portfolio management, financial advisors are often focused on measuring their clients' risk tolerance and risk capacity when it comes to potential investment losses and crafting an asset allocation accordingly. For retired clients (who are likely drawing down their assets to support their spending needs), a related element of risk comes into play: the chances that they will run out of money before their deaths (or, at the other extreme, have a significant amount of unspent assets that they might have used to better enjoy their retirements).

Bernstein and McQuarrie coin the term "omega" to represent a spectrum on which individuals sit based on which of the retirement spending risks they fear most. For example, an individual who most fears running out of money might derive significant utility (i.e., reward or satisfaction) from maintaining a large, liquid, low-risk asset buffer that assures them that they won't run out of money (even if it means spending less than they might be able to afford to in retirement). On the other end of the "omega' spectrum, another individual might fear that they will die without fulfilling all of their desired experiences and are willing to prioritize higher spending, perhaps seeking to "Die With Zero" (or as close as to it as practicably possible).

Which suggests that advisors might keep "omega" in mind when considering which retirement income strategy to use with clients. For instance, a client who fears running out of money might be nervous about a strategy that starts with a higher initial withdrawal rate, even if the advisor can show that it is likely to be sustainable (perhaps with spending adjustments) over the course of their retirement. On the other hand, a client who wants to prioritize spending might balk at a strategy that frequently leads to millions left in the bank at their deaths (particularly if they don't have large bequest goals).

Ultimately, the key point is that one size doesn't fit all (clients) when it comes to retirement spending, as some might derive significant benefit from having (unspent) savings left in the bank while others might get more utility from spending their nest egg down. Which suggests that better understanding where a client sits on the "omega" spectrum upfront can help inform which income strategy is chosen (or perhaps ensure a prospect is a good fit for an advisor's retirement income specialty that they prefer to use across much of their client base?).

Helping Retired Clients Get Over The Spending Hump

(Danielle Labotka | Morningstar)

For many individuals entering or in retirement, the prospect of running out of money during their lifetimes can keep them up at night (while for advisors, the specter of sequence or return risk sometimes looms large). In reality, though, many retirees end up not only with leftover savings at their deaths, but sometimes even more than had when they retired (perhaps due to a positive sequence of returns), which suggests that some retirees could spend more during their 'golden years' without threatening the sustainability of their financial plan.

Nevertheless, some retirees might find it hard to boost their spending even if their portfolio's trajectory can support it (and meet their legacy goals as well). While certain retirees in this situation might be hesitant to spend on certain day-to-day 'extravagances', they might be willing to spend more on particular goals that align with their values. With this in mind, financial advisors could help such clients by undertaking an exercise based on the PERMA framework (Positive Emotion, Engagement, Relationships, Meaning, and Accomplishments) developed by Dr. Martin Seligman, which can unearth client values that can then be shaped into financial goals. For instance, an individual who gains energy by being in nature might be motivated to spend more on travel if it meant being able to see more national parks while another who values family relationships might 'splurge' more often on airplane tickets (perhaps even in business or first class!) to see loved ones across the country (even if they still decide to be more thrifty in other areas).

In sum, the specter of destitution in retirement can loom large for many retirees (including those who are seemingly wealthy), offering financial advisors the opportunity to both 'run the numbers' on how much a client might be able to spend while minimizing their chance of outliving their money and, more qualitatively, helping clients identify what value the most and presenting opportunities to spend more (sustainably) in these areas!

Retirement As A Sprint, Not A Marathon

(Fritz Gilbert | The Retirement Manifesto)

Much has been written about the length of retirement in the modern era, sometimes stretching for three decades or longer for certain retirees. Which could encourage some retirees to treat it as a 'marathon', where they start relatively slowly (perhaps limiting their spending and dabbling in a few activities) and attempt to keep a moderate 'pace' throughout their remaining years.

However, a key issue is that all retirement years aren't created equal, as while an individual might have a certain expected lifespan (though this isn't guaranteed, as some individuals unfortunately die unexpectedly relatively early in their retirements), their 'healthspan' (i.e., the number of years they are in good health and can take on a wider range of activities) typically is more limited, with healthier years much more likely to occur relatively early in retirement. Which suggests that many retirees will want to lean into these 'go-go' years and front-load spending so they can take on more active pursuits that might not be a possibility for them down their line (and perhaps boost spending on activities that could extend their healthspan?).

Of course, given that too much spending early on in retirement (particularly if an individual experiences a negative sequence of returns) could severely limit assets available to support their needs in their later years, financial advisors can play a valuable role not only in modeling up front the potential effects of increased spending early in retirement but also in monitoring their client's plan as they move through retirement (as a positive sequence of returns could mean that they can maintain a higher level of spending for longer than they might have anticipated originally).

In the end, while retirees will typically hope to live as long as possible, treating each year of this period equally when it comes to spending could result in less aggregate enjoyment than they might get from starting with a spending "sprint" in their early years on high-value (and high-energy) activities (particularly if they are willing to be flexible with their spending in their later years).

Creating Cash Compensation Structures That Meet The Needs Of Growing Firms And Their Advisors Alike

(Isaac Mamaysky | Advisor Perspectives)

When a financial advisory firm founder makes their first hire or two, they might design a compensation package on the fly, perhaps based on what they can afford to pay given the status of company revenues at the time. However, as a firm grows (alongside its employee headcount), taking a more standardized approach to employee compensation (perhaps using benchmarking studies to create a baseline and then creating a firm-specific structure) can help both increase cost predictability for the firm and set expectations for employees (potentially boosting staff retention in the process).

When it comes to cash compensation, one option is to offer a percentage of the revenue an advisor brings in (keeping some of the revenue with the firm to cover expenses and a profit margin). This model could be attractive to established advisors with strong client books and those who want to be compensated directly for new clients they bring on. On the other hand, it might be less attractive to newer advisors (as their smaller AUM bases would mean earning less income) and those who prioritize consistent income (as market downturns could lead to less income for the advisor despite working with the same number of households). This model also can provide less flexibility to the firm (as there is less discretion on how much to pay on an annual basis).

An alternative approach is to offer advisors salaries, with the option to include a bonus as well. This can be attractive to advisors who want stability (in the form of a set salary) with the ability for upside potential through any available bonus. Firms are able to adjust salaries based on different ways advisors contribute to the firm's success beyond their personal assets managed (e.g., mentoring newer advisors) and tailor the bonus structure in a way that meets their and their employees' goals. Offering discretionary bonuses provides firms with maximum flexibility (perhaps accounting for revenue and employee growth while keeping in mind possible expense growth as well), though this style can be less favorable to advisors (as they might largely be in the dark on how much they will receive in a given year). At the other end of the spectrum, a firm might use a formula-based bonus, which offers greater transparency to employees but less flexibility for the firm. Other bonus-related considerations for firms include whether to base it on firm-wide performance or on individual targets (or a hybrid of the two) as well as when to pay it (with annual payments made the following year serving as a rolling incentive for employees to stick around at least until it's made).

Ultimately, the key point is that because employee compensation is typically the top expense on an advisory firm's profit and loss statement (and because financial advice is a human-centric business), crafting a compensation structure (including cash compensation and, potentially, an equity compensation component if desired) that matches the firm's business goals while attracting and retaining top-notch staff can lead to more sustainable growth over time.

The Case Against Incentive Compensation

(Bob Veres | NAPFA Advisor)

In the product sales corner of the financial advice world, a significant amount of an individual's compensation is often determined based on production incentives (e.g., commissions for selling a particular product). While fee-only firms don't offer this type of pay for their advisors, they still might base advisor compensation on hitting certain targets (e.g., new clients brought on or assets added).

A problem, though, with a compensation model that relies in whole or in part on incentives (as described in a recent white paper by advisor consultant Brett Davidson) is that it can encourage employees (advisors or otherwise) to focus specifically on these targets (perhaps to the detriment of other company goals) or, even worse, to try to 'game' the system to hit their marks without adding the desired value to the company. For instance, a program that rewarded London bus drivers for completing their routes on time ended up incentivizing them to pass by crowded bus stops to avoid slowing down their route. Such misaligned incentives could be found in the advisor world as well. For instance, offering a bonus based on converting a certain percentage of prospects into clients might incentivize an advisor to meet with fewer prospects (who they think have the highest chance of closing), perhaps resulting in fewer (potentially good-fit) clients than they might otherwise have added.

Another potential downside of incentive-based compensation is that employees might feel micromanaged and limited in their creativity to complete their jobs. Which could ultimately lead to reduced feelings of autonomy (one of the key contributors to advisor wellbeing, according to Kitces Research). At the same time, because simple salary alone might not be enough to motivate employees, firms can consider other forms of compensation, from profit-sharing arrangements to peer and management recognition.

In sum, while offering incentive compensation might seem like an effective way to encourage employees to meet certain firm-desired targets, crafting targets carefully (to avoid disincentivizing work on other goals) and considering the secondary effects of this approach (e.g., whether it's limiting employee autonomy) might be needed to prevent (or at least minimize) unintended consequences.

4 Motivators That Drive Successful Advisor Compensation Plans

(Angie Herbers | Nerd's Eye View)

Human beings respond to incentives, and as a result, compensation is one of the most influential drivers of employee motivation and is often used by employers as a way to guide their team's behaviors. For example, some employers design their compensation structures to reward employees for experience gained and/or length of service provided to the company, or by adjusting an employee's pay to compensate for certain benefits (e.g., paying extra to cover health insurance costs when the company has no group insurance plan, or by reducing pay to compensate for retirement plan contributions the company makes on behalf of the employee). Very frequently, though, employers overlook the fact that it is not actually the money itself that influences their employees but, rather, it is what the money offers to or makes possible for the employee that matters most. And it's those emotional connections to money that ultimately must be tapped effectively in order for compensation incentives to actually create the desired business outcomes.

According to Herbers, there are four common mistakes that advisory firms tend to make when creating their compensation structures. The first is designing an incentive structure without a clear focus – or with a focus on too many objectives – as many firm owners try to tie too many metrics to compensation (e.g., revenue, and profit, and client service) rather than on prioritizing one main objective with a clear focus (and a better chance of meeting that objective) for all. A second mistake is using compensation as a way to adjust for benefits; either increasing pay to make up for benefits the company does not offer (e.g., higher pay for no health insurance… but then what happens if the firm adds health insurance later?) or reducing pay to compensate for benefits the company does offer (e.g., reduced pay in exchange for employer contributions to an employee's retirement plan… that the employer was probably going to make anyway for their own benefit!?). A third mistake that firm owners make is offering partnership rights as a form of compensation (i.e., not paying partners a salary for their active role in the business, and letting net partnership distributions be the primary or sole compensation), as the income a partner receives for ownership and what an employee receives for work in the business reflect two very different functions.  And the last common mistake is neglecting to update the compensation structure over time, which should be reviewed and updated often to respond to the behaviors that the firm wants to influence (as the needs and demands of the business itself do tend to evolve over time as well).

When it comes to the actual drivers that make employees want to earn compensation, there are four basic feelings that serve as central motivators, and certain types of compensation offered can generally serve to satisfy these feelings for employees: 1) control (regular base salaries that employees can rely on receiving for the role they play in the company), 2) advancement (incentive-based pay that gives employees a sense that what they do is helping them advance through the ranks), 3) assurance (benefits offered to convey that employers care about their employees and are taking measures to provide care for them), and 4) achievement (compensation tied to a career-track plan). And for employees to develop trust in their employers, they need to have at least some of these feelings satisfied by the compensation they receive for the work that they do.

Ultimately, the key point is that if employers take the time to analyze their teams' compensation needs, and decide which of the four motivational drivers are most important to their employees (and it may be the case that all four are important to a firm), firm owners can better understand which compensation structures would be most beneficial to implement, and why. And when effective compensation structures are in place that satisfy employees' motivational needs, the result often produces more streamlined employee management… not to mention inevitably enhancing the firm's culture and overall morale, as well!

Did You Just ChatGPT Me? How To Respond To A Client's Advice "Challenge"

(Meghaan Lurtz | (Less) Lonely Money)

Much has been written about the potential for Artificial Intelligence (AI)-powered tools to displace the work of (human) financial advisors (or not) as well as on how advisors might leverage AI tools within their practices. Another angle to the AI and financial advice conversation, though, involves how clients might use AI tools themselves in conjunction with their work with an advisor.

For instance, a client might come to a review meeting with their advisor curious about a particular investment product or planning strategy that they don't currently use but which a chatbot (e.g., ChatGPT or Claude) told them might be appropriate for their situation (after uploading their financial plan or data). In this situation, an advisor's first instinct might be defensiveness ("Do you trust the chatbot more than me?!"), but this approach might cause the client to shut down and avoid bringing questions to the advisor in the future.

An alternative approach in this situation is to first lead with gratitude (e.g., by thanking the client for trusting the advisor with this question or issue) and then lean in with curiosity (e.g., by asking the client what they found and why it matters to them). This can shift the focus of the conversation from instructive (i.e., the advisor tells the client why the AI output might be incorrect) to a collaborative process (where the advisor can then offer their perspective on the situation).

In the end, clients bringing the output of AI tools to the meeting table aren't necessarily demanding a change to their financial plan but rather are often coming from a place of curiosity, which the advisor can validate before offering their perspective on the issue. Which could ultimately better keep the lines of communication open between the two parties and build trust between the client (who knows their advisor will be there to hear them out) and the advisor (who can be more confident that the client won't make a major financial move without consulting them first).

Why The AI Job Apocalypse (Probably) Won't Happen

(Ezra Klein | The New York Times)

Amongst the many potential effects that could come with advancements in AI technology is severe disruption in the labor market. At the extreme, some observers have suggested that AI tools might put a significant percentage of the population out of a job, as companies adopt (potentially less expensive) AI tools that can perform functions previously completed by humans.

Klein is skeptical of some of the more apocalyptic predictions, however. To start, while previous technological advances were disruptive, they often led to new business opportunities and jobs to go with them. For instance, the introduction of the electronic spreadsheet (which, at the time, greatly sped up the time needed to perform certain accounting functions) didn't lead to the end of accounting as a profession (the number of accountants actually quadrupled over the next 40 years, instead offering the opportunity for workers to perform more advanced calculations and generate better financial intelligence.

Another angle to the question of AI and employment is how economists have found that when individuals get wealthier (which could occur amidst an AI productivity boom), they tend to spend more on goods and services with a human element. For instance, even though it's easier and simpler than ever to make gourmet coffee at home, coffee shops and (human) baristas continue to thrive as they offer an element of added luxury. This could be seen in the financial advice world as well; AI tools could give advisors the opportunity to serve more clients (who could have an added interest in a human touch in a world where digital advice is more widely available).

In sum, a dramatic increase in unemployment caused by advances in AI isn't a certainty by any means. In fact, it seems quite possible that AI could be supportive of job creation as it opens doors to new projects and businesses, even if the jobs within them might look different than certain careers that exist today.

AI Isn't Coming For Your Job. It's Coming For Your Mind

(Tom Slater | Baillie Gifford)

The future of employment in a world with more advanced AI systems has been a hot topic of late, though the effects of AI can already be seen today, not necessarily in unemployment rates but rather in how certain jobs are being done and how the next generation of company employees are being hired and trained.

While the internet provides a gateway to the world's collective knowledge, it can require a user to search for and consult multiple websites to understand a particular issue. AI chatbots, however, can synthesize copious amounts of information and provide an answer written in natural language all in response to a single user prompt. Which makes it easier than ever to find the (hopefully correct) answer to a question and, at the next level, have AI actually complete tasks without having to learn them in the first place.

However, reliance on AI can come with weaknesses for both individuals and companies. At the individual level, having AI complete tasks directly requires putting significant trust in the tool being used, particularly for those without the underlying skills. While an expert (e.g., a lawyer or financial planner with background expertise in their field) might be able to verify AI-produced outputs, a newer employee or consumer might not be able to determine whether the AI's (often very confident!) answer is correct. In addition, while experienced professionals might be augmented by AI tools, companies might be hesitant to bring on newer employees, who might have a higher cost than AI tools who could (at least initially) perform required tasks faster and more accurately. This pattern could create a large expertise gap at the company, though, as the ranks of senior employees dwindle over time, leaving the company reliant on (imperfect) AI tools (and perhaps a few individuals to operate them).

Ultimately, the key point is that while traditional educational methods and job training involve significantly more time and friction compared to consulting an AI tool, these seeming deficiencies could ultimately prove valuable for both employees (who can become better at discerning whether AI-produced output is valid) and companies (who can ensure they maintain a level of expertise that can't be copied by a competitor that primarily relies on AI).

We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or send an email to [email protected] to suggest any articles you think would be a good fit for a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "WealthTech Today" blog.