Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with the big news announcement that risk tolerance software maker Riskalyze has raised a whopping $20 million Series A round to fuel its continued growth. Also in the news this week was the announcement that Morningstar has formally launched Analyst Ratings on ETFs (to complement its ratings on mutual funds), and that the latest data from the SEC shows it is still struggling to materially improve its examination rate of investment advisers, because the ranks of the RIA community are growing faster than the SEC's ability to scale up its exams!
From there, we have several practice management articles, including: the challenging "walls" that advisory firm owners must clear in order to transition from "small" solo practices into mid-sized businesses; why defining a niche is about more than just stating you work with a certain type of clientele, and instead is about explaining the unique outcomes you can create for those clients; and a look at how the latest DoL fiduciary FAQ could lead to cuts (or at least potential changes) to the typical broker-dealer grid payout system.
We also have a few more technical planning articles, from a look at how to help clients understand their longevity risk (and why typical life expectancy statistics understate their risk of outliving their money), to a discussion of the favorable tax rules for a personal residence (from the mortgage interest deduction to the capital gains exclusion), and why prenup agreements are becoming increasingly popular for young professional couples.
We wrap up with three interesting articles: the first looks at how the focus of financial planning is shifting from helping clients maximize their dollars and their Return On Investment (ROI), and instead is about helping clients live a better life with the dollars they have (improving their "Return On Life"); the second is a reminder that there's a fundamental difference between being a financial advisor salesperson and a client-centric professional (even if you're a salesperson who tries to do the right thing for clients); and the last is a powerful call to the financial planning profession that its time to step away from the broader financial services industry and find our own place in the world... at least, if the industry and its product manufacturers are willing to let go.
And be certain to check out Bill Winterberg's "Bits & Bytes" video at the end, which this week includes coverage of the latest Schwab technology roadmap, Riskalyze's $20M Series A funding, the announcement that SS&C (owner of Black Diamond) has acquired Salentica CRM, and TD Ameritrade's acquisition of Scottrade (including Scottrade Advisor Services) and the rollout of TDA's new "robo" solution Essential Portfolios!
Enjoy the "light" reading!
Weekend reading for November 5th/6th:
Riskalyze Draws $20 Million In Capital For Robo Platform And Other Adviser Products (Liz Skinner, Investment News) - The big industry news this week was that risk tolerance software maker Riskalyze raised a whopping $20M of institutional capital from FinTech venture capital firm FTV Capital (also known for being an early investor in Financial Engines). The investment represents a "very minority" stake in the company, and CEO Aaron Klein will remain in charge of Riskalyze. Notably, Riskalyze already employs more than 100 between its Sacramento and Atlanta locations; nonetheless, the capital is intended as "growth equity" to expand Riskalyze's product and engineering teams to roll out additional products (in addition to likely enhancing its core "risk alignment" software for evaluating whether a prospective client's portfolio aligns with his/her risk tolerance, and also Riskalyze's "Autopilot" robo-onboarding tool for new clients). Given that Riskalyze is already one of the fastest growing 'startups' directly serving financial advisors, many eyes will be watching to see how Riskalyze can deploy the capital and grow from here, both for the sake of Riskalyze itself, and also from the perspective other advisor FinTech companies that may try to validate the advisor market opportunity in the eyes of venture capital firms based on Riskalyze's success.
Morningstar Launches ETF Analyst Ratings For 250 Funds (John Waggoner, Investment News) - In 2011, Morningstar launched its "Analyst Ratings" on mutual funds, providing a rating of Gold, Silver, Bronze, Neutral, or Negative, based on five qualitative factors of Process, Performance, People, Parent, and Price. Now, Morningstar is expanding its ratings to 250 ETFs around the globe, including 100 here in the U.S. Of course, given that most ETFs are indexing products, the focus on performance and process aren't necessarily as relevant; still, Morningstar emphasizes that knowing who the people (management team) and parent companies are is relevant for ETFs, if only to ensure the ETF provider can consistently execute on its index-tracking mandate. Notably, so far none of the 100 U.S. ETFs ranking by Morningstar has a negative rating, though in part that's because Morningstar started with the more popular and already widely adopted ETFs, that tend to be from more reliable providers. Ultimately, the firm is aiming to rate up to 250 U.S. ETFs, which should cover about 80% of the total assets in ETFs, though notably it would still leave more than 1,500 of the less-popular or esoteric (or what Morningstar outright labels "half-baked or quarter-baked") ETFs unrated for the foreseeable future.
A Visit From the SEC? Doesn’t Happen for Thousands of Money Managers (Jean Eaglesham, Wall Street Journal) - Over the past 13 years, the SEC has doubled its spending on examiners who go out to do on-site audits of (SEC-registered) investment advisory firms, and the total number of investment adviser exams is up almost 20% over the past year. Yet despite this ramp-up, the SEC will still only visit an estimated 12% of all RIAs (down from 18% in 2004, though up from a low of about 8% in 2011 and 2012). In addition, more than 1/3rd of the 12,200 mutual fund companies, wealth managers, and investment advisers subject to SEC purview have still never have an on-site check for signs of fraud or misconduct. The problem is that despite the additional exam resources over the past decade, the number of SEC-registered investment advisers (generally, those with over $100M of AUM) has grown faster than the SEC's ability to expand its resources (now growing by about 500 per year, and up nearly 50% in 2004) - an issue that may only be further exacerbated if the DoL fiduciary rule accelerates the breakaway broker trend. Notably, the SEC emphasizes that it does review advisor Form ADVs as well, and that on-site exams aren't their only means to monitor advisory firms, although clearly on-site exams are an important part of the process (and currently about 8% of investment adviser exams result in referrals to the SEC's enforcement arm for potential wrongdoing). A stopgap proposal by SEC chair Mary Jo White to improve exam oversight, which would require investment advisers to pay outside auditors to do the compliance checks instead, has currently stalled out, as of the remaining 4 SEC commissioners, two are worried about the costs and effectiveness of such a plan, and the other two seats are currently vacant. Though ultimately, the biggest concern remains the sheer efficiency of SEC examiners (or lack thereof), as even the most "productive" SEC office's examiners only looked at an average of 4.6 firms in 2015, while the slowest office averaged only 2.4 firms per examiner all year.
From Small To Medium: How TO Manage Growth Fears (Mark Tibergien, Investment Advisor) – The independent advisory model first emerged in the 1980s, with some building registered investment advisors (RIAs) and others working as independent contractors for independent broker-dealers (IBDs)… both of which were a significant departure from the past, when “advisors” (predominantly brokers) were captive employees of large broker-dealers. With time, though, independent advisory firms have grown, putting advisor/founders in the challenging position of needing to become managers and business leaders, in addition to “just” the financial advisor they once set out to be. For instance, just a decade ago, it was rare for any independent RIA to reach $1B of assets under management; now, Cerulli estimates there are 650 RIAs with over $1B of AUM, growing to such a size that there are actually once again more employee advisors than owner advisors in the independent RIA community. And that means advisor/founders tend to hit “walls”, where growth or quality suffers, until the firm expands the staff, infrastructure, or whatever else is necessary to clear the hurdle. Though Tibergien cautions that the core issue is making sure that the advisor/founder has a clear vision about where the firm is heading – including and especially if it’s intended to continue growing – so that the walls can ideally be anticipated and navigated more smoothly.
Your Niche Needs To Be More Than “I Work With…” (Steve Wershing, The Client Driven Practice) – One of the key benefits of having a niche is that it helps to drive referrals, by literally making the advisor more “referrable” in the first place. However, the real key to having a niche that generates referrals is not just to say “I work with…” that particular niche, but to craft a solution relevant for the niche that speaks to how your (niche) service will improve their situation. In other words, they don’t want to work with you because your niche is to work with them; they want to work with you because you provide an outcome that improves their (financial) situation. For instance, it’s not “My niche is working with doctors” but instead “I help physicians in private practice streamline reimbursement, improve cash flow, and give them more time to practice medicine rather than chasing payments”, or “I show new doctors at <Anytown> Medical Center how to maximize their benefits plan to make sure they are making as much progress as possible on their retirement goals.” Because those are outcomes that will appeal to the doctors in the niche, and paints a real picture of what, exactly, you will do for them. And notably, while outcomes like “trust” or “peace of mind” may result as well, the ideal is to be more specific about the real outcomes (because it’s those that lead to trust and peace of mind!). So what kinds of outcomes can you communicate for your target clientele? Obviously it will vary by the niche, but Wershing suggests outcomes in four potential categories: 1) a solution to a technical problem; 2) an experience the client prefers; 3) a process that caters to the unique needs of your target market; or 4) helping them achieve a non-financial (but still relevant-to-the-niche) goal.
Are Brokers Facing A Grid Pay Cut Under Fiduciary? (Kenneth Corbin, On Wall Street) – With the latest issuance of the DoL’s “Frequently Asked Questions” (FAQ) guidance on its fiduciary rule, brokers are preparing for changes to the grid compensation structure for 2017. The key issue is that to comply with the Best Interests Contract Exemption, broker-dealers need to structure broker compensation – including the grid – in a way that doesn’t unduly incentivize brokers to sell one product over another (particularly in the same category), nor to push to meet sales goals for high compensation. Accordingly, in Q&A-9 of the FAQ the DoL specifically noted that grid payout rates must be the same across all the products in a category – e.g., that all annuities must have the same compensable revenue with the same grid payout rate, and ditto for all mutual funds, etc. Furthermore, if firms are going to use graduated grid payout rates (with higher payouts at higher levels of production), the increments must be gradual enough to not unduly incentivize brokers to try to reach the next tier. Notably, though, the rules don’t necessarily require compensation to be lower; however, if compensation must be equalized, any particular broker could find the new 2017 grid to materially change compensation in either direction. On the other hand, brokers who relied heavily on upfront commission compensation will likely see at least some decline, as more consistent compensable revenue across all the products in a category will likely trim at least the highest payout options that may be available today.
Helping Clients Understand Their Longevity Risk (Wade Pfau, Journal of Financial Planning) – For retirees, longevity risk is the risk of outliving retirement assets, especially for those who outlive their life expectancy and find they don’t have enough assets to sustain the “unexpectedly” long time horizon. And longevity risk is a challenge, because while we have incredibly good estimates of longevity for the entire population – thanks to the law of large numbers – and can predict how many people will live or die each year, there’s no way to know which people will pass away, which is a serious problem for any particular retiree who doesn’t know how long to plan for! And Pfau notes that most financial advisors tend to underestimate how long clients will live, for three primary reasons: 1) the commonly cited life expectancy is life expectancy from birth, but those who have already lived to age 65 (and weren’t killed by any of the things that kill us in our younger years) have a longer life expectancy from there; 2) common mortality tables, like the Social Security Administration’s period life tables, look at survival and mortality rates today, but aren’t adjusted for expected improvements in future health (the way that actuaries do it when they project survival/mortality rates for life insurance and annuities); and 3) there is growing evidence that those of above-average socioeconomic backgrounds tend to have above-average life expectancy as well (which means the “typical” financial planning client is likely to have above-average life expectancy compared to the general population). As a solution to address these issues, Pfau suggests using the Longevity Illustrator tool created by the American Academy of Actuaries and the Society of Actuaries. And the difference isn’t trivial; according to the updated data, even non-smokers who are otherwise in poor health are expected to live to age 83 (males) or 86 (females), with a 10% chance to live to age 95 and 97 respectively!
Understanding Tax Deductions On A Residence (Julie Welch & Cara Smith, Journal of Financial Planning) – Tax preferences associated with the primary residence are some of the most commonly claimed tax benefits, including the home mortgage interest deduction, and the capital gains exclusion on the sale of a primary residence. They do have important limitations, though. For instance, with the home mortgage interest deduction, the loan must be secured by your primary or second home, and it has to actually be a home (i.e., sleeping accommodations, a toilet, and cooking facilities), in order to deduct the interest. And for loans against a primary or secondary residence, there are actually two types of debt for mortgage interest deduction purposes: acquisition indebtedness (used to acquire, build, or substantially improve the home), and home equity indebtedness (any borrowing that does not qualify as acquisition indebtedness). The types matter, because interest on acquisition indebtedness is deductible up to $1M of debt principal, while home equity indebtedness interest is only deductible for the first $100k of debt. In addition, the interest for home equity indebtedness is not deductible for AMT purposes. And if you rent out the property for more than 14 days, you must also personally use the property for the greater of 14 days or 10% of the rental days, to still deduct the interest. When it comes to the capital gains exclusion on a primary residence, the key requirement is the “ownership and use” test – that to claim the exclusion of up to $250,000 per person ($500,000 for a married couple), they must have both owned and lived in (i.e., used) the home as a primary residence for at least two of the past five years. And notably, the deduction can be claimed repeatedly – every two years – as long as the rules are met each time. Although special rules apply when a primary residence has been converted to a rental property, or vice versa.
Prenups For Young Professionals (Katie Leonard & Kevin Rubin, Private Wealth) – Classically, the prenuptial agreement has been about a wealthier spouse wanting to protect assets, but there is an emerging trend of using prenuptial agreements for young professional couples. The reason is that in situations where both members of the couple come to the table with what could be substantial income and career potential – including growing a business – it’s important to establish up front how alimony and property division may be handled later (e.g., by waiving alimony for each member of the couple, and allowing them to keep their separately-accumulated assets, or even agreeing that no marital property with joint marital rights will be created during the marriage). Notably, subsequent actions of the couple should ideally be done consistently with the prenup – if assets are meant to remain separate in the event of divorce, the couple should maintain separate banking accounts while married (to make it easier to clearly split as appropriate); alternatively, the prenup can clarify that even if property becomes jointly titled, it may not be joint marital property (e.g., a home that becomes jointly owned during the marriage can be protected in the prenup for just one spouse). Since the exact requirements for a prenup vary from one state to the next, though, the couple should be certain to engage competent legal counsel, and respect the prenup requirements for enforceability (e.g., that each spouse should retain independent counsel to review the terms before signing).
Why ROI Is A Dead End And How To Explain Your Value Proposition (Mitch Anthony, Journal of Financial Planning) – Mitch Anthony is the founder of the Financial Life Planning Institute, the author of "Storyselling for Financial Advisors", and was an early pioneer in the life planning movement… or as he puts it, the movement of “knowing the story before doing the math” when it comes to a financial plan. In other words, it’s not about how much money there is, or how to maximize it… the fundamental question is what the money is for in the first place, and what might be possible to achieve with the money that’s available (as most clients don’t even know what their goals are until they’ve explored the possibilities, first!). Of course, the purpose of money and its related possibilities varies greatly from one person to the next, which is why a good discovery process is necessary in the first place. In addition, the reality is that those goals and desires can and often do change over time… which means the discovery process itself isn’t just a one-time event when starting with a client, but an ongoing need. In fact, arguably the whole “optimization” problem for financial planners to solve is how to help clients maximize not their Return On Investment (ROI), but their Return On Life (ROL), constantly focusing on how to direct resources in a way that helps them live a fulfilling life. For instance, from the ROL perspective, the reality is that a plan for retirement itself may not even be a good goal to have, given that so many people don’t actually find an idle retirement life to be fulfilling; instead, it’s about how to leverage money to enjoy the journey of life itself, recognizing that the need to be engaged never ends. Accordingly, Anthony suggests that the real value proposition of financial planning is providing organization, accountability, objectivity, proactivity, education, and partnership, all of which help clients on the journey of life to maximize their return on life.
Are You A Salesperson Or A Professional Planner (Bob Veres, Financial Planning) – Today’s world of financial planners includes both those who operate legally as salespeople (registered representatives of broker-dealers), as well as those who are hired and paid directly by the client (registered investment advisers). Veres notes that while both may call themselves “advisors”, there are fundamental differences in the focus between the two. For instance, salespeople are compensated to acquiesce to client fears and simply sell them a product they ‘want’, while a professional is bound to actually educate clients on why what they want to buy may not actually be good for them. Salespeople are rewarded to “solve” client financial problems with product solutions, while professional advisors are more likely to seek ‘procedural’ solutions (e.g., using trusts, tax strategies, etc.) that don’t necessarily involve a product. Salespeople are encouraged to use the financial planning process to discover business opportunities, while the professional advisor focuses on the planning process to actually chart a course to achieving client goals. Salespeople are encouraged to ask happy clients for referrals to get more business opportunities, while professional advisors focus on monitoring a happy client’s continued progress towards financial goals to stay on track. The fundamental point – when you transition from being a salesperson to a professional advisor, there really is a substantial shift in where you focus your time, energies, and desired outcomes in working with clients.
A Call To Industry! Let Our Profession Go… (Dick Wagner, Financial Advisor) – While people often use the terms interchangeably, there is an important difference between the broad financial services industry, and those of us who are financial planning professionals. The professionals are the ones who deliver financial planning, and are both a subset of the broader industry, and ultimately rely upon the broader industry to supply the financial products that our clients need (through the banking, investments, and insurance channels). However, Wagner suggests that right now, the industry has too much of a direct hold on the profession, both dictating much of its regulation, holding “advisors” as agents of broker-dealers (instead of serving the client first and foremost), while also trying to obfuscate the line between the professionals and the industry’s own salespeople. In fact, arguably the DoL fiduciary rule is simply an attempt to reassert the separation between industry and profession, and between salespeople and advisors (after the SEC has failed to enforce the separation under the Investment Advisers Act of 1940). Nonetheless, for financial planning to reach its full potential as a profession, it must ultimately separate from its industry and product roots, where financial planning is no longer just a “productive marketing system” for financial services products, but a bona fide service that serves the client first and foremost.
I hope you enjoy the reading! Please let me know what you think in the comments below, and if there are any articles you think I missed that I should highlight in a future column!
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!
Great stuff this week, particularly the longevity discussion.
On the home mortgage interest deduction, can you, or someone, confirm a thought of mine, or provide more context if I’m wrong?
My thought is this. Although it’s better than not having it, I’d argue that for many people the mortgage interest deduction is greatly overstated. This is because one only gains the deduction to the extent that the aggregate of itemized deductions outweighs the standard deduction. For those with a large mortgage, this is likely the case, however, for the masses, who may have a, for example, $250k mortgage and may not have a large number of other deductions, this deduction isn’t likely to extend much, if at all, beyond what they would get with the standard deduction.
Larry Frank says
The longevity article was interesting. A couple of observations:
1) The choice of what age to plan to is biased by the current perspective based on a single, fixed planning period. Rather, using the tables (one that may be more applicable to specific client by client characteristics, e.g., annuity tables for healthier clients, Social Security for general health) and doing a rolling income calculation – better known as a review – allows for spending while they’re more likely to be alive rather than saving money for years they may not be here – and adjusting the time frame each year from the life tables, instead of fixating on that same end age. This is explained in the same JFP edition in this paper
2) Yes, people are living longer – and the tables adjust for this over time. Tables from 2000 are not the same as they are today. Rather than make predictions, simply use the tables in a rolling review manner. As the tables adjust, use the new data. Again – this is moving away from a set period, set end age, perspective. Indeed, sometimes longevity goes down, not up as recently reported
Wade did a great job bringing the longevity tables into focus. The profession should adjust from trying to set a single period way out to when the tables end, and use the tables in a rolling manner during reviews. Retirees may be able to spend more precisely when they’re more likely to be alive, than saving it for years they’re less likely to be here to spend it. Adjust it each year with an eye on the new out years.
Great newsletter Michael!
Amy Calistri says
Really enjoyed the “Return on Life” piece by Mitch Anthony. We recently asked a prospective client (recently retired) what her financial goals were – what she wanted to achieve with her money. She said no one ever asked her that before. She had been told she “should” be working toward maximizing what she left to her (financially independent) kids. That’s how she was sold an annuity with more riders than a subway. In the end, she was so excited to know she could decide her financial future – and there were advisors to help down that path. NOBODY ASKED HER.