Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the big announcement that Charles Schwab is entering the “robo-advisor” fray, with an offering called “Schwab Intelligent Portfolios” that will be available for consumers (and shortly thereafter as a white-labeled version for RIAs on the Schwab platform), and will be free to use with only a $5,000 minimum (and automated tax-loss harvesting starting at $50,000).
From there, we have a number of practice management and technology articles this week, including a discussion of what to look for when merging smaller advisory practices into your own firm (from the perspective of someone who’s done several such deals, both successful and not), tips for advisors who want to get “cyber liability” insurance to protect against the risk of cyber attacks and wire fraud, guidance on how to form a client advisory board, and a look at how an online chat tool on your website can help engage visitors and turn them into genuine client prospects.
We also have a few more technical articles this week, from a Morningstar analysis of the rise of passive investing that finds predictions that consumers are abandoning active management for low-cost indexing may be overstated, to a look at why it’s so significant that the Treasury and IRS gave the green light to deferred income annuities inside target-date funds, an analysis of consumer borrowing options that find borrowing from a 401(k) loan may be quite underrated (at least relative to the other borrowing options typically available to consumers), and a good summary of basic strategies and resources to families who haven’t saved enough (or anything) for college and are now trying to figure out what to do as the kids prepare to apply.
We wrap up with three interesting articles: the first looks at how not only do many advisors have a problem branding themselves, but that the entire financial planning profession has a “branding problem” due to a lack of clear vision about its fundamental role and purpose in society; the second is a critique by GMO’s James Montier of the whole concept of managing companies by trying to “maximize shareholder value” and how the incentives that have been created are actually damaging (long-term) shareholder value; and the last is a fascinating look at how too much positive thinking can actually be damaging to achieving goals, and that balancing optimism with realism is crucial to obtain the motivation necessary to pursue the goal… which has some notable implications for how we as financial planners guide our clients towards retirement! Enjoy the reading!
Weekend reading for November 1st/2nd:
Schwab to Unleash No-Fee Robo-Giant (Janet Levaux, ThinkAdvisor) – This week, the big news was Schwab’s announcement that it will be launched its own “robo-advisor” platform, called Schwab Intelligent Portfolios, to compete with the rise of alternative platforms like Wealthfront and Betterment. The Schwab offering will be made available directly to consumers in the first quarter of 2015, with a version for RIAs to come “shortly thereafter”, and will be available for free (no program fees, no commissions or trading costs). The platform will be implemented with fully paperless account opening and management tools, and using exchange-traded funds (ostensibly using Schwab’s existing OneSource no-transaction-fee ETF platform, and possibly including some of Schwab’s own ETFs); the advisor version will allow advisory firms to use their own branding and “tinker” with the ETFs used to further customize client portfolios (and then apply their advisory fees on top of the platform). The Schwab Intelligent Portfolios offering will have a $5,000 minimum, and at the $50,000 threshold will include automated tax-loss harvesting services (also free), and for consumers who want more help, existing Schwab financial consultants will be available to help them. The Schwab announcement follows on the heels of TD Ameritrade announcing last week that it would take an open-architecture approach to the robo-advisor space by opening up Veo to integrate with outside robo-advisor platforms, and in the prior week Fidelity announced that it would be partnering with Betterment to provide a white-labeled “Betterment Institutional” solution to advisors on its platform.
Growth Through Synergy (Roy Diliberto, Financial Advisor) – Diliberto’s firm has acquired or merged in several advisory practices over the years, and shares some perspective on the experiences, including acknowledging from the start that he doesn’t even view them as “mergers” or “acquisitions” but simply as “enhancing the practice by adding offices that have been successful in providing planning services” with the hope that the synergy will provide a 1+1=3 outcome. That being said, Diliberto notes that his earliest attempt as such a merger was actually a mistake; the firm tried to grow by adding advisors who had successful practices and merging them in, with the hopes those advisors would then learn from and adopt his firm’s financial life planning process, but found instead that the advisor was so accustomed to his existing way of doing things that the intended change and anticipated synergy never occurred. Thus, the second time Diliberto looked to merge a firm in, he did it with a planning team he already knew shared his values around the kind of (life) planning that should be done with clients, and with whom he already had a relationship (through both volunteer engagements and as a study group member). The second merger was so successful, Diliberto recently completed a third, and in reflecting back on what has worked, provides the following takeaways and suggestions: philosophical alignment (about investing, and planning) is key, and the firm should be able to articulate the characteristics of an ideal (merger) candidate (in Diliberto’s case, it was sole proprietors or small firms who wanted to leverage his firm’s infrastructure so the advisor could spend more time attracting and servicing clients); will the merged advisor be able to adapt to an ensemble approach to compensation, or do prefer to remain in a silo method of compensation (and is that aligned to the method the acquiring firm prefers?); how will the technology of the two firms be integrated (and/or what is the path to migrate to common software systems); and will merged advisors be partners/shareholders, and if so under what terms and conditions?
Cybersecurity Insurance: What Advisors Need To Know (Paul Hechinger, Financial Planning) – As the focus on cybersecurity and the fears of hackers stealing client data are on the rise, advisors have been increasingly looking for cybersecurity insurance to protect themselves from the potential business impact of a cyber breach. Unfortunately, though, the reality is that there is no uniform type of coverage to protect against cybercrime events; advisors will likely need to buy and piece together a few different types of coverage to protect against all the risks. There are “cyber” policies that can help protect against risks like wire transfer fraud, but this in turn still requires firms to have a clear process for managing wire transfer requests; if the firm takes a wire transfer request by email and doesn’t confirm it with a callback, the coverage will not pay the claim. In one instance where a firm completed a (fraudulent) wire transfer via email, the firm’s cyber liability policy didn’t pay (for failing to complete a callback), and the firm’s fidelity bond wouldn’t pay for the employee’s mistake either; in the end, the only thing that protected the firm was its E&O coverage, which paid simply because the employee (cyber) mistake was deemed to be employee negligence (which the traditional E&O policy covered in this case, though even that isn’t true of all E&O coverage). Similarly, not all policies will cover third-party vendors or independent contractors the advisor may be working with (especially if they have private client data). The bottom line: at best, coordinating coverage to protect against cyber liability is complex and risks having coverage gaps, though notably following the processes and procedures that insurers will require (e.g., a callback for every wire transfer request) may already be the best defense for many (but not all) risks.
How To Form A Client Advisory Board (John Bowen, Financial Planning) – As the advisory world gets more competitive, some advisors are trying to figure out how best to refine their client solutions by going right to the source: forming a “client advisory board” to ask the clients what they want. The advisory board itself should be formed from amongst your top clients – ideally, those who are in the niche or target market in which you want to further grow – and who are willing to work with you collaboratively to improve the business to help both you and the service they receive from you for themselves. Start by simply asking the clients out to lunch one by one, invite them to provide some feedback on the firm, your services, and why they chose you, and if their responses feel productive, you can invite them to come to the first meeting of your advisory board (and if they like the experience, invite them to come back to participate on an ongoing basis). Be certain to thank clients for serving on the board as well; an annual lunch or dinner at a nice restaurant is a good way to show gratitude. The recommended goal is to have about 12-15 of your ideal clients on your advisory board, and recognize that ultimately the benefit is not merely getting their feedback about how to improve your services and solutions, but also to get ideas for new opportunities, and simply to engage some of your top clients to they’re more involved with the firm (and thus, may potentially send more referrals, as well).
How I Turbocharged Engagement w/ My Website Viewers: One Advisor’s Success Story (Dave Grant, Blueleaf Advisor Blog) – Advisor Dave Grant has been trying to build his niche advisory firm, Finance For Teachers, with a strong focus on digital marketing techniques, including blogging, and has now written more than 90 posts for his site. He found that his content was drawing in visitors to the site, who in turn were signing up for his newsletter service to stay in touch, but weren’t necessarily engaging any further with his website or communicating with him directly. To address this, Grant added an online “Chat” program to his website (using ClickDesk), so now whenever he’s actually at his desk with some time, he can log in and visitors to his website are notified that he’s available for chat. ClickDesk allows a number of customizations for the look and feel to match your website, and captures daily logs of activity and chat history (important for compliance purposes); the cost is a very affordable $14.99/mo. Since adding the option, Grant has found his engagement increased, as the easy “chat” feature giving them instant access to a planner seems to work better than the potential awkwardness of a phone call (since they can quit at any time without repercussions); yet despite the ease of disconnecting, one recent visitor to his website posed what started as a relatively simple question about a pension, which then morphed into a broader discussion about the reason for retiring, and is now in the process of scheduling a time to meet to potentially become a client. In fact, Grant has found overall that his rate of scheduling prospective client meetings is up a whopping 500% since installing the program.
Death Of Active? (Jeffrey Ptak, Morningstar) – The big story of the past several years has been the rise of passive investing. Five years ago, active funds accounted for about 79% of total fund assets, and now it’s down to only 71.5%; given the sheer size of the investment marketplace, that 7.5% erosion is a very big number. The consumer narrative around this shift has been that consumers are recognizing the importance of low cost, the weaknesses of active management, and that the overall shift towards passive investing is simply the beginning of the end of actively managed funds altogether because consumers have “seen the light”. Yet a deeper look into the trend by Morningstar reveals a different perspective. First, the reality is that a huge portion of the shift is attributable just to mega mutual fund giant American Funds alone, and is occurring despite the fact American Funds actually are relatively low cost, and actually do have many funds with solid long-term records; in fact, Morningstar notes that some of American Funds’ decline may be more about advisors breaking away from broker-dealer firms, adopting an AUM model, and adopting a wider array of investment solutions as a result. Second, the ‘trend’ towards passive indexing is not uniform; it’s occurred primarily in the US large-cap (especially large-cap growth) space, where 80% of large-blend funds are lagging, but active management has held fairly even in other market segments, such as foreign stock funds (even though 70% of those are trailing on a 10-year basis, too, and they tend to cost even more than US funds!). Third, it’s hard to justify that consumers are simply adopting a low-cost indexing narrative when alternative funds have gathered a whopping $152B of net inflows in 5 years, even while charging a whopping 1.72% average expense ratio, possibly a reflection of the emerging new paradigm of pairing ultra-low-cost “beta” like broad-market index funds with supposed “alpha-generators” like alternatives; in this context, the passive funds may still be part of an overall combined strategy that is substantively more active in focus (and ditto for the rising trend of managing ETF portfolios). Last, the reality is that in the bond space, actively managed fund flows are actually trouncing passive index funds, but a more than 2-to-1 margin. Overall, the conclusion is that unless investors for some reason only believe in indexing in one asset class (large-cap US stocks), the presumed death of active management may still be overstated in the current environment.
Regulators Give Annuities a Green Light for [Employer] Retirement [Plans] (Jeff Holt, Morningstar) – Last week, the U.S. Treasury and IRS issued guidance in the form of IRS Notice 2014-66, which will allow target-date funds to purchase deferred income annuities with a portion of investor assets beginning at their age 55 (with the annuity allocation increasing until the investor reaches age 65). At retirement, the investor will receive a certificate stating his/her claim to the annuity payments. The significance of the IRS guidance, when paired with supporting guidance from the Department of Labor that a target-date fund with such an annuity allocation can still be a Qualified Default Investment Alternative (QDIA), is that an allocation to a guaranteed annuity income stream may now be a default investment option for employer retirement plans. However, the Treasury guidance does not specifically permit variable annuities with guaranteed lifetime withdrawal benefits, just “traditional” lifetime income annuities with a deferred annuity starting date that begins at retirement. Notably, though, the IRS and DOL guidance merely make it possible for target-date funds to include deferred income annuities; plans will still have to adjust their recordkeeping systems, evaluate and vet insurance carriers for default/counterparty risk (not to mention carriers may need to further develop products to be made available for target-date funds in the first place), so at best it will still take time for annuities to be adopted, with the possibility that plans will decide not to follow through when the time comes. Nonetheless, given the incredible inflows that have gone to target-date funds over the past decade since they were allowed to be a QDIA under the Pension Protection Act, the new guidance means that potentially significant dollars may start to flow to retirement income annuity vehicles.
Are Your Clients Making The Right Loan Choice? (Nina Tang & Timothy Lu, Journal of Financial Planning) – While many advisors caution against clients taking loans from a 401(k) plan, the authors of this study note that for those who do need to borrow, a 401(k) loan may actually be preferable to alternatives like home equity loans and especially credit cards and other higher-cost loans (e.g., payday lenders). Of course, the borrowing amounts from a 401(k) plan are limited – to no more than half the retirement account (and not to exceed $50,000), and the loan must be repaid within 5 years, but the rate is typically fixed at a relatively low cost like Prime plus 1%, which is drastically lower than most available alternatives for consumers. On the other hand, there are caveats to the 401(k) loan strategy – the most notable that if the employee leaves his/her job (or gets laid off), the loan comes due and must be repaid within 90 days of leaving (and if the loan is defaulted on, it is deemed to be repaid with the 401(k) account balance, which can trigger income taxes and an early withdrawal penalty). And of course, building an emergency reserve and just not needing to take a loan in the first place is even better. But nonetheless the authors make the case that for those who do need to borrow, the 401(k) loan is underrated, especially since consumer research shows that 401(k) loans tend to be used as a last resort behind other much-more-expensive alternatives (especially credit cards). And the strategy is arguably even more effective in environments like today, when interest rates (and expected returns) are lower.
A College Financial Aid Guide for Families Who Have Saved Nothing (Ron Lieber, New York Times) – While the standard wisdom is that parents should commit to college savings while their children are young, the reality is that not all families have the financial wherewithal to do so, and as a result many must engage in more “late stage” planning for college funding when it’s time for the kids to actually go to college without any college fund available (or at least, with far too little to cover the explosively rising costs of college education). For those who want to evaluate their options, the first step is to visit the College Board’s “Expected Family Contribution” (EFC) Calculator, so they can understand what EFC amount will be plugged into the formulas for determining Federal financial aid once the FAFSA (Free Application for Federal Student Aid) is completed (although some colleges will subsequently tweak this number with their own adjustments). And notably, it’s important to recognize that while many families attempt to manipulate assets to massage the numbers in the formula, the biggest driver of the EFC is actually the family’s income, not its assets. Next, you can use the Federal government’s “College Navigator” site to find out the cost of attendance at various schools, broken out into tuition, room-and-board, and other expenses, along with estimates of the typical “net price” (net of scholarships) that families pay at various income levels; families can also use CollegeData.com to estimate potential merit aid. Many schools will put forth additional financial aid to try to attract top students – which may mean applying with an eye towards which schools the student may rank as a “top” potential student (i.e., having a good student apply to top schools that are highly competitive already will be less likely to yield additional aid, as the schools have little need to give aid away to attract the students). For many families, the only choice may be to borrow. If that’s necessary, the best option is to have the student get Federal student loans that allow up to $31,000 in loans at favorable rates and the option of an income-based repayment plan later; the next option is with private student loans, which often have higher rates, and may require parents to co-sign the loan, which means the credit of the parents can be damaged if the child has trouble repaying in a timely manner. If the parents wish to borrow directly, they will typically do so through Federal Plus loans, but parents should be cautious not to burden themselves too much pushing for the loans, especially since there may be limited options to refinance (and the parents cannot later refinance the loan into the child’s name).
Likelihood Of Confusion (Dick Wagner, Financial Advisor) – Branding is crucial for any business, but it’s also important for an entire profession, and Wagner points out that financial planning has a serious lack of clarity around its own brand. Developing the CFP marks and building the six-step financial planning process has been a good start, but the challenge remains that consumers still don’t really know what they’ll get when they work with a financial planner – a product pitch or a professional engagement – and as the recent CFP Board ads themselves have highlighted, consumers have a lot of trouble figuring out who to trust and how to tell the difference. While some might blame competitors for obfuscating the landscape, Wagner suggests that the blame lies with those who are trying to establish the profession as well, who have failed to clearly define its particular mission and purpose in the world, and therefore allowed the confusion to proliferate. The problem is so striking, that even as a financial planner, if you’re at a party and hear someone else there is a financial planner, do you tend to think “Excellent! A colleague!” or “uh-oh, a competitor” or “yeah, sure… better hold on to your wallet!” If your instinct is to lean towards the negative, then you too are acknowledging that our emerging profession hasn’t done enough to create the necessary clarity and consistency of brand for consumers. The situation is not helped by the fact that financial planning actually is a very effective tool for facilitating a product sale. Yet ultimately, Wagner suggests that to be recognized as a true profession and gain clarity, we must clearly define how we help clients and serve the public, and move beyond our (admittedly deep) product-sales-based roots, which should eventually lead to (state) licensure of financial planners to provide a bright and clear dividing line for consumers (as is the case for doctors and lawyers).
Shareholder Value Maximization: The World’s Dumbest Idea? (Usman Hayat, CFA Institute) – In a recent keynote address for the 2014 European Investment Conference, James Montier of GMO raised the interesting question of whether the reigning management paradigm of “maximizing shareholder value” has actually been a bad idea that’s done more harm than good, contributing to short-termism by corporations and rising inequality. In fact, Montier points out that despite its popularity, there’s actually little academic support for the idea at all; it actually originated from academia (in particular, a famous op-ed written by economist Milton Friedman in 1970), and in turn led to some research about how to align management incentives with maximizing shareholder value (e.g., by shifting compensation to have heavy components of stock ownership and stock options), but there was little to validate whether the underlying idea was actually healthy. And Montier suggests that it has not been healthy; case studies of companies that have shifted to management focus to shareholder value maximization are not showing superior results, and overall stock returns during the “shareholder value maximization era” of the past 20 years have not been outperforming prior time periods (and in fact when controlling for shifts in valuation, have underperformed by about 2%/year!). Montier implies that the concept of maximizing shareholder value wasn’t necessarily bad, but notes that the way management incentives are structured has been very damaging; the rewards of structures like stock options are so large, management has been distracted from the underlying goal and is overly incentivized to game the system for themselves, driving short-termism and exacerbating inequality as top management extracts huge rewards from the system, and possibly even leading to broader-based challenges like the declining share of labor in GDP and the declining level of business investment as a percentage of GDP.
The Problem With Positive Thinking (Gabrielle Oettingen, New York Times) – Conventional wisdom says that people who maintain an optimistic outlook will be more successful and able to achieve their goals by eliminating the “negative self-talk” that can slow us down. However, research over the past two decades suggests that the situation is far more nuanced. One seminal study found that, when women were faced with a weight-loss challenge, those who had the most positive thinking actually lost the least weight a year later; since then, the results have been replicated in a wide range of settings and contexts, from college students wanting a date to hip-replacement patients hoping to get back on their feet and more, and the consistent outcome has been that those who fantasized about the happy outcomes and getting there smoothly were actually the least likely to do so! The problem appears to be that while dreaming about a future goal does actually calm us down, and measurably reduce out blood pressure, it also saps us of the energy needed to take action to pursue the goal; in other words, positive thinking about a goal fools our minds into perceiving we’ve already attained it, slackening our readiness to actually pursue it! Notably, this doesn’t mean the solution is to just discard all happy talk and “get real” by dwelling on the challenges and obstacles, as that’s equally problematic. Instead, the best path appears to be “positive thinking with realism” or “mental contrasting” where you first imagine the positive goal and achieving it, but then also spend some time thinking about the obstacles that could stand in the way; this appears to help people better attain achievable goals, and notably also helps to (beneficially) dissuade them from unrealistic/unattainable ones. While the research has focused on this mental contrasting approach in situations like getting better grades, managing workplace stress, or have better relationships, it arguably has some great parallels for the challenges faced by financial planning clients, and provides some insight about how we as planners can better help clients to achieve their goals.
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.