Enjoy the current installment of “Weekend Reading For Financial Planners” - this week’s edition kicks off with the news that amid a wave of mergers, the number of broker-dealers has declined during the past few years, according to a report from FINRA. And while broker-dealers are also seeing a decline in the number of their registered representatives, their profits have actually ticked higher in the past few years, perhaps supported by strong market performance buoying their growing fee-based business. At the same time, the number of RIAs continues to grow, suggesting that the shift toward advice-centric, rather than product-centric, business models is continuing!
Also in industry news this week:
- For the largest independent broker-dealers, fee-based revenues now make up a majority of total revenue (with commissions accounting for just 34%) according to a recent survey, representing a dramatic shift from just a decade ago, when commissions made up the majority of revenue.
- Why FINRA is considering raising the barriers for retail investors to purchase a range of “complex” investments, potentially including leveraged and inverse ETFs
From there, we have several articles on industry studies:
- A recent study shows that advisors at RIAs tend to focus on expense ratios rather than recent performance when picking mutual funds for client portfolios, leading to better outcomes than both broker-dealer registered representatives and dual registrants, who are more likely to choose more expensive, active mutual funds
- A Cerulli study indicates that in a world of low stock and bond returns, advisors are increasingly considering alternative asset classes to generate income for clients
- How an advice-only business model can allow advisors to be more creative with their service offerings and reach a wider range of potential clients
We also have a number of articles on retirement planning:
- The pros and cons of using a Qualified Longevity Annuity Contract (QLAC) to insure clients against longevity risk while deferring some RMDs
- Why clients with long-term care policies may soon see premium increases and how advisors can help these clients analyze their options
- Why planned changes to “Traditional” Medicare could make it look more like Medicare Advantage and how advisory clients might be affected
We wrap up with three final articles, all about how one’s personality can affect their wealth:
- How certain personality types are correlated with increased lifetime earnings among the general population, and why the traits that lead to success for financial advisors might be different
- How the personality traits associated with ‘self-made’ millionaires differ from those who inherited their wealth, and why these traits could affect client behavior
- Why certain characteristics are associated with the ability to separate ‘financial BS’ from genuinely profound advice
Enjoy the ‘light’ reading!
(Andrew Welsch | Barron’s)
Just as there has been a wave of merger and acquisition activity among RIAs in the past few years, broker-dealers have seen a similar trend, with large national and regional brokerages buying up their smaller counterparts. And at a time of increasing technology and compliance costs, as well as increasing competition from fee-only RIAs, there have been declines in both the number of broker-dealers and their registered representatives.
According to FINRA’s 2022 Industry Snapshot, there were 3,394 broker-dealers registered with FINRA in 2021, down 41 from 2020 (with 150 firms leaving the industry and 109 firms entering) and a decline of 1,432 firms since 2017 amid the wave of consolidation. Further, the industry has seen the number of its registered representatives shrink as well, falling to 612,457 last year from 617,531 the year before (representing about 44,000 departures from the industry and 39,000 newcomers). In addition to consolidation, the growth of RIAs has likely contributed to these trends as well, with the number of RIAs growing to 31,669 in 2021 from 29,600 in 2017.
Notwithstanding the declining number of broker-dealers and registered representatives, industry revenues rose during the period, with aggregate revenue for FINRA-registered firms increasing to $398.5 billion from $361.9 billion in 2020. In addition, pre-tax net income increased in 2021 to $91.8 billion from $77.3 billion in 2020, perhaps as a result of efficiencies created from industry consolidation and/or strong stock market returns in 2021 that contributed to fee-based income.
So while the brokerage industry continues to bring in healthy profits, its declining headcount and the simultaneous growth of RIAs during the period suggest that an advice-centric, rather than product-centric, approach is increasingly seen as an attractive option for many registered representatives. And these advisors have a range of platforms to choose from, both for those who want to remain in the broker-dealer space and for those who want to make the jump to an RIA!
(Bruce Kelly | InvestmentNews)
Traditionally, broker-dealers brought in most of their revenue through commissions generated from the sale of investment products. But with the growth of online platforms and greatly reduced trading fees that allow consumers to manage their own investments, as well as the growth of fee-only RIAs, and regulatory actions, such as the introduction of the SEC’s Regulation Best Interest, have made generating revenue through commissions more challenging.
In fact, according to an InvestmentNews survey, in 2021 fees comprised 54% of revenue from the top 25 independent broker-dealers surveyed, with 34% of revenue coming from commissions, and 12% coming from other sources (primarily generated from interest-rate spreads). This is a stark contrast to how these firms operated previously; for example, in 2013 commissions accounted for 52% of revenue, with fees only accounting for 34%. And this shift has been profitable, with advisors at six independent broker-dealers bringing in an average of at least $500,000 in fees and commissions in 2021.
One of the drivers of the fee-based revenues (typically taken as a percentage of assets under management) was likely the strong stock market performance in 2021, with the S&P 500 returning 28.7%, including dividends. And while the negative equity returns so far in 2022 could reduce these AUM fees, revenues could be buoyed by rising interest rates, which benefit broker-dealers through increased margin interest rates and better interest-rate spreads on client cash holdings in money market accounts.
In the end, the survey results reflect the growing attractiveness of an advice-centric approach for advisors across industry platforms. And so, as Regulation Best Interest has made it harder for RIAs (which have traditionally been advice-centric fiduciaries) to differentiate themselves from the broker-dealer competition, it is becoming increasingly necessary for advisors at RIAs to go beyond differentiating themselves not only on their fee structure and standards of conduct, but also by prioritizing what clients want most from their advisor and on the services they provide for clients!
(Sam Potter and Katie Greifeld | Financial Advisor)
The number of exchange-traded products has exploded in the last several years, moving from simple index Exchange-Traded Funds (ETFs) to much more complex products. And while more opaque investments were traditionally limited to accredited investors (who meet certain income or asset requirements), these new ETFs are available to all, regardless of their assets or investment knowledge. And while the value of index ETFs can assuredly decline, the newer products (such as leveraged and inverse ETFs) have the potential to lead to much more significant losses.
And so, FINRA issued a regulatory notice in March calling for comments on whether the barriers should be raised on investing in a range of exchange-traded products, possibly including leveraged and inverse vehicles, cryptocurrency-linked funds, and defined-outcome strategies. These barriers could potentially include enhanced disclosures, a “knowledge check” for retail customers, a requirement to seek FINRA approval for the advertising of complex products, controls on push notifications on digital devices, and heightened supervision of investment recommendations.
Proponents of enhanced requirements for the highlighted investment vehicles suggest that self-directed retail investors are behind the boom in popularity of these products and many of them might not understand the potential risks involved, potentially putting a significant amount of capital at risk. However, other observers suggest that it will be difficult to measure an investor’s knowledge and the firms who produce the products suggest that the investments are being unfairly singled out and that any rules could potentially apply to a broad range of investment products.
So while it remains to be seen whether FINRA will take any action on this issue (the comment period ends on May 9), advisors can help clients who might be interested in complex investment products to understand their risks and whether they are appropriate given the clients’ investment strategies and risk tolerance. Because while many of these products might look attractive when markets act in their favor, the downside can be significant!
(Ginger Szala | ThinkAdvisor)
For investment advisors, there are many ways to assess whether a specific mutual fund might be appropriate for a client. From considering whether it is actively or passively managed, to its expense ratio, to its recent and historical performance, there are many dimensions from which to choose. And recent research indicates that the type of firm an advisor works for influences this decision.
According to the study “Does Advisor Channel Influence Passive Fund Choice” by Michael Finke, Aron Szapiro, and David Blanchett, advisors at RIAs favor more salient characteristics such as expense ratios, while representatives from broker-dealers and dual registrants are more likely to use recent returns and active investment strategies. The authors surveyed a total of 459 advisors from the three types of firms and found that one-third of advisors with RIAs build client portfolios mainly with passive investments, more than twice the percentage of broker-dealer representatives and dual registrants. The study concludes that because the expense ratio is the most important characteristic predicting future returns, advisors at RIAs who focus on expense ratios and implement a passive investment strategy tend to outperform their counterparts.
Interestingly, while dual registrants act as fiduciaries when providing investment advice to individuals, their fund preferences did not differ from broker-dealer representatives across a range of characteristics. The authors suggest that this is because they operate within a brokerage ecosystem that may influence how they are trained to select fund investments and develop an investment strategy (i.e., such training might encourage the use of actively managed funds that have a revenue-sharing agreement with the advisor’s parent firm).
The key point is that advisors with RIAs appear to improve client investment outcomes by focusing on the expense ratios of mutual funds and implementing a passive investment strategy. And while dual registrants theoretically straddle the line between RIA advisors and their broker-dealer counterparts, the study shows that their investment preferences more closely resemble the latter (perhaps signaling the importance of differentiating them from advisors who act as fiduciaries at all times!).
(Karen DeMasters | Financial Advisor)
When constructing a portfolio, including assets that have non-correlated performance can help steady returns and dampen portfolio volatility. And while stocks and bonds have historically been largely uncorrelated, 2022 has brought sharp declines to both asset classes. And so, some advisors appear to be turning to alternative investment classes in an attempt to generate returns and income for their clients.
According to a report from financial services research and consulting firm Cerulli Associates, alternative mutual funds gathered positive net flows during March and added $200 billion in net flows in the first quarter, while mutual fund assets were relatively flat and were down more than 6% through March. Among the alternative asset classes seeing growth are non-traded real estate, interval funds, and business development companies, which together held almost $300 billion in assets at the end of 2021, up sharply from $176 billion at the end of 2020.
And according to a Cerulli survey taken last year, 59% of advisors using alternatives were doing so to create current income for their clients. Notably, while these alternative investments have the potential to generate returns and income at a time when traditional asset classes are weaker, they can come with drawbacks, such as illiquidity and higher fees, that might not make them appropriate for some clients.
Ultimately, while a period of negative returns for both stocks and bonds can be challenging for advisors and their clients, the decision to invest client assets in alternatives requires research (to first determine how the asset class works) and consideration of the fees and liquidity involved. In addition, this current period could be a good time for advisors to stress test client portfolios to ensure that they continue to be positioned to meet their clients’ goals!
(Jeff Benjamin | InvestmentNews)
Investment management has traditionally been at the center of financial advisory services. In prior decades, consumers had no choice but to go through a broker to invest. But thanks to steady improvements in technology, investors have the option to invest on their own (and benefit from transaction costs approaching zero!). And while many consumers still seek professional investment advice, advisors can also reach "DIY" investors by adjusting their fee model and focusing their services on other areas of financial planning.
For example, while an individual might feel comfortable managing their investment portfolio, they might have questions about claiming Social Security, education planning, or estate planning strategies. And while some of these clients might want an ongoing relationship, others might want to have their concerns addressed through irregular meetings or on a project basis.
With this in mind, offering an advice-only service allows advisors to be more creative with their fees and reach a wider range of potential clients (who might not have sufficient assets to be served by other advisors). While charging AUM-based fees remains the predominant fee structure for advisors to manage investments, advice-only advisors have a range of options, from hourly planning fees, to ongoing retainers, to project-based billing. And advisors who want to charge for advice do not have to turn down clients who are interested in investment advice; in these cases, the advisor could charge a separate fee for investment management services (which could simply entail making portfolio recommendations for the client to implement themselves rather than managing client funds directly through a custodian).
The key point is that for advisors who are less interested in investment management and want a more flexible business model, an advice-only approach can allow them to serve clients whose needs align with the advisor’s own expertise and ability to provide value!
(Christine Benz | Morningstar)
With life expectancy increasing during the past few decades, many retirees are concerned about longevity risk, or the risk that they will outlive their assets. This leads some retirees to use guaranteed income products, such as annuities, to reduce the risk that a market downturn could imperil their retirement spending. And for retirees with assets in qualified accounts (e.g., Traditional IRAs or 401(k)s), a qualified longevity annuity contract (QLAC) could be a potential solution.
QLACs are a form of deferred annuity, where an individual makes an upfront payment in return for a fixed payment at a later age. For example, a 70-year-old retiree could purchase a QLAC today and begin receiving payments at age 80 (and the payments they receive at that time will be larger than if they purchased an immediate fixed annuity and began receiving payments today). What makes QLACs different from other deferred annuities is that they are purchased using funds from a qualified account, and those funds are removed from Required Minimum Distribution (RMD) calculations once the retiree reaches RMD age (thereby potentially reducing their tax bill in the years before QLAC payments commence). Once annuity payments begin, the retiree pays ordinary income tax on the payments. Notably, an individual is limited in the amount they can contribute to a QLAC – up to 25% of their portfolio or $145,000, whichever is less.
So while QLACs have many potential benefits, including addressing longevity risk and offering a tax benefit, they come with drawbacks as well. For example, because a QLAC is a fixed annuity, it comes with inflation risk (this can be addressed with a rider, but this will lower the payment amount). Also, the retiree faces insurance-company risk (as they will not receive payments until several years after purchasing the QLAC). In addition, one of the risks of any deferred annuity is that the retiree could die before receiving any benefits or soon after payments commence (though their beneficiaries could receive a payout if a period-certain annuity was purchased).
In addition, the tax savings on RMDs might not be worth the foregone growth had the assets used to purchase the QLAC been invested (given that the retiree might not live long enough to receive sufficient payments to even match the principal used to purchase the QLAC). Further, the accelerated payments of a QLAC in later years can deplete a qualified account even faster than normal RMDs would have anyway!
Ultimately, the key point is that while a QLAC represents a potential way for retirees to address longevity risk, the tax benefits alone might not make it the best option for a given client. For advisors, a client’s life expectancy, assets, income needs, tax situation, and estate goals are all considerations that can be taken into account before purchasing a QLAC or other longevity annuity.
(Allison Bell | ThinkAdvisor)
Both long-term care insurance (LTCI) companies and those they insure have seen dramatic changes over the past several years. Amid falling interest rates and greater-than-expected claims activity, the LTCI market has shifted significantly. This has led to significant premium increases, both for newly purchased policies and for those who had been paying premiums for many years. Notably, these premium increases must be approved by each individual state, which is left to balance the need for insurers to remain solvent against the ability of consumers to handle the premium increases.
In an attempt to facilitate state evaluations of premium increase requests from insurers, members of the National Association of Insurance Commissioners (a group of state insurance regulators) voted in April to adopt the Long-Term Care Insurance Multistate Actuarial Review Framework, under which states that choose to do so can get help from a team of experienced LTCI actuaries with analyzing rate increase applications. This could speed up the process of application reviews and increase the consistency of the final results. However, because some LTCI issuers have been waiting for the framework to be released to ask for premium increases, policyholders could see a flurry of new LTCI rate increases in the near future.
And so, advisors with clients that have LTCI policies can help them explore their options to deal with any rate increase. For those who can afford the increased payments, continuing to pay on a current policy is often a better value than purchasing a new one (which are priced based on the updated interest rate and use assumptions), but it can be worth checking rates with other insurers. But in those cases where the premium increase makes the insurance unaffordable, advisors can help clients explore options to modify and/or reduce coverage to maintain the original premiums. Typically, reducing the benefit period, or the rate on the inflation rider (particularly for older clients), represents better options than reducing the daily benefit amount.
The key point is that long-time LTCI policyholders continue to bear the brunt of the insurance companies’ original mispricing of the policies and could experience further premium increases. That said, advisors can help guide clients through assessing their potential LTCI needs and how to best balance premium increases within their broader financial plan.
(Mark Miller | Morningstar)
Those who get their health insurance through Medicare have two options: “Traditional” Medicare, which is a fee-for-service program where healthcare providers bill Medicare directly; and Medicare Advantage, a managed-care alternative run by private companies. And while Medicare Advantage plans have become increasingly popular thanks in part to their often low premiums and additional services offered, individuals in these plans are typically steered toward in-network providers, which can be limited in certain areas.
But now, the Centers for Medicare and Medicaid Services (CMS) has announced planned changes that could make traditional Medicare look more like Medicare Advantage. Under the plan, Medicare will enter into contracts with Accountable Care Organizations (ACOs), healthcare provider groups that will receive a flat annual payment to provide care for enrollees in traditional Medicare.
Proponents suggest that the plan will incentivize the ACOs to work together as teams to provide comprehensive care for patients, and that the plan could lead to reduced costs for the Medicare program by paying a flat fee per enrollee rather than being charged for each procedure. On the other hand, skeptics of the plan suggest that the plan could lead to lower-quality service for enrollees in traditional Medicare, because the flat fees they receive will incentivize the ACOs (which are often owned by for-profit investors) to cut costs where possible.
Medicare officials have said they expect all traditional Medicare beneficiaries to be in ACOs by 2030, and those individuals will receive a letter from CMS informing them whether their current healthcare provider is part of an ACO. And so, advisors can be on the lookout for clients raising concerns about their Medicare benefits and medical providers, particularly as part of a broader conversation during Medicare’s open enrollment period at the end of the year.
(Miriam Gensowski | Harvard Business Review)
The “Big Five” theoretical psychology framework analyzes an individual’s personality across five dimensions: extraversion, conscientiousness, openness to experience, agreeableness, and neuroticism. This framework has been used to explore how an individual’s unique personality is related to everything from academic achievement to marriage success to criminality. One particular area of focus has been the relationship between an individual’s personality and their income.
Gensowski sought to explore this relationship by looking at personality and income data for a group of 595 men whose income was tracked between the ages of 18 and 75 (it is also worth noting that the study began in 1922 and the men surveyed were all in the top 0.5% of the population in IQ). By controlling for a variety of factors, she found that men who were more extraverted on average earned $600,000 over the course of their career (about 15% of lifetime earnings) than a more introverted peer. And this effect was equally large for conscientiousness. On the other hand, men who were more agreeable earned about $270,000 less over a lifetime than the average man. Further, these effects only began to appear at age 30, and only fully unfolded as the men entered their prime working years, between the ages of 40 and 60 (perhaps as the men entered higher-paying managerial jobs).
Given the limitations of this research (e.g., only studying men in a variety of industries who were in their prime working years several decades ago), it is worth exploring whether these effects are seen today among financial advisors. According to Kitces Research, while the majority of advisors are extraverted, it turns out the biggest traits that defined the longest-standing and highest-income advisors are being highly conscientious and very agreeable (but not necessarily extraverted!). In addition, the results of the research suggest that one of the biggest “deal-breaker” traits for success as a financial advisor is that they must have very low neuroticism (i.e., especially high emotional calm).
Of course, these research results represent trends across the studied population, so having a particular personality type does not exclude an individual from having success in financial advising or another field. And so, in reality, it might be most important to maximize what your personality type has to offer and to work to develop the patience, focus, and grit that often lead to professional success!
(John Anderer | Study Finds)
There are a wide range of factors associated with personal wealth, from years of education to choice of occupation. At the same time, researchers have considered whether more innate characteristics, such as personality type, are also related to the wealth an individual accumulates over their lifetime. And according to researchers studying German millionaires, a certain “rich” personality profile was associated with high wealth.
According to their study, millionaires tended to have higher risk tolerance, emotional stability, openness, extraversion, and conscientiousness. In fact, the closer an individual’s personality tracked this profile, the more likely they were to be wealthier. The researchers also found that this effect was more prominent among “self-made” millionaires than those who inherited their wealth, suggesting that the “rich” personality profile was actually a contributor to wealth generation as opposed to developing as a result of having wealth.
Of course, while the researchers found that this personality profile was associated with wealth generation, it does not necessarily mean that everyone with this profile will necessarily become wealthy. For example, having high risk tolerance is associated with positive aspects such as entrepreneurship and stock ownership, but also with overly optimistic decision-making and losses due to corruption.
The key point is that understanding client personality traits can be a useful exercise for advisors, from assessing their investment risk tolerance to their retirement income preferences, which can help them better understand their clients and how best to build a financial plan that is in sync with their personality type!
(Mario Kienzler, Daniel Västfjäll, Gustav Tinghög | Journal of Behavioral and Experimental Finance)
The world of financial advice is full of maxims and jargon, which can be confusing for consumers (and sometimes for advisors as well!). And while much of this advice is accurate, or at least made in good faith, some of it is made in bad faith (often by those trying to sell a product) and can be considered ‘financial BS’.
With this in mind, Kienzler, Västfjäll, and Tinghög set out to see how good consumers are at detecting financial BS and which types of individuals are most susceptible to it. They created a scale that included actual profound statements (e.g., William Feather’s “A budget tells us what we can’t afford, but it doesn’t keep us from buying it”) as well as made-up, pseudo-profound statements (e.g., “A cheap loan is beyond all new destiny” and “Your money transforms universal actions”). They then conducted an online survey of Americans to see how well they could identify which statements were truly profound and which were financial BS.
The good news was that nearly all of those surveyed (86%) could distinguish genuine financial statements from BS to some extent. However, there was variability in this ability, and those who were particularly vulnerable to financial BS were more likely to be young, male, have a higher income, and be overconfident regarding their own financial knowledge. And while the ability to detect BS was related to several positive abilities, such as greater objective financial knowledge, these individuals also felt more insecure about their finances.
When it comes to seeking financial advice, the amount of potential jargon used can be intimidating for many consumers, which can lead them to avoid engaging a financial professional for fear of being judged. The need to balance clarity with technical details also increases the importance for advisors of explaining the “how” of what they do in addition to the “what” to demonstrate their value to prospects and clients. And as the results showed that those with higher incomes were more susceptible to financial BS, advisors working with higher-income clients can pay careful attention that they are explaining their process and advice in a clear and truthful way (and provide context to guide these clients away from pseudo-profound advice and products they might encounter)!
We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in 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 "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.