Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with a look at the latest part of the Senate Republican tax plan generating buzz amongst advisors… that all investment sales may be required to use FIFO treatment in the future, eliminating the specific lot identification method, which would substantially curtail tax loss harvesting strategies.
Also in the recent news is the announcement that the military is overhauling its traditional 20-or-nothing pension system to a slightly scaled down version of the pension combined with government involuntary plus matching contributions to the Thrift Savings Plan (and a choice for enlisted military with less than 12 years of experience about whether they want to stay in the old system or switch to the new one). And there’s also a timely article on providing ideas for client holiday gifts, just in time for Black Friday sales!
From there, we have several articles about pricing and marketing advisory services, from a look at how to properly set and then communicate your fees, to an outsider’s perspective on how financial planners should be pricing their services (or rather, offering a menu of variously-priced services), and a good reminder about how it’s impossible to effectively market the value of your services until you get a clear understanding of your internal business strategy on how you plan to create (and differentiate) your value to your intended target market.
We also have a few practice management articles, including: how a growing number of advisory firms are shifting from lifestyle practices to enduring businesses (which provides more upside value potential to sell the business, but introduces substantial complexity along the way); a good primer on how a valuation expert looks at the real issues involved in trying to determine an advisory firm’s value; and a look at what today’s RIAs may be missing in how the DoL fiduciary rule will apply to them (including during the current “transition BICE” period until the full rule takes effect in July of 2019).
We wrap up with three interesting articles, all around the theme of how the advice industry, and the needs to be successful in the industry, are changing: the first looks at the challenges in attracting women into the financial planning profession, noting that the real challenge may not be the concern about whether there’s “too much math” or not, but that too many financial planning jobs are still overly sales-oriented, too inflexible, and too unwilling to given upwardly mobile Millennials the autonomy they crave; the second explores the emerging field of financial therapy, and how just as financial planners have been blurring the line between advice and product sales, so too is financial therapy blurring the line between advice and making (and treating) mental health diagnoses; and the last notes that as more advisors master the technical skills in financial planning, it’s the communication skills that are increasingly important, especially in a world where money remains such a taboo subject, which means perhaps it’s time to rename the “soft skills” to something more commensurate with the gravitas they are taking on in the path to being a successful financial planner!
Enjoy the “light” reading!
Weekend reading for November 25th – 26th:
Senate Tax Bill Could Make Stock Sales More Expensive (Tracey Longo, Financial Advisor) – While there’s been substantial recent buzz about the new tax brackets, expanded standard deduction and reduced itemized deductions, and new preferential tax rates for pass-through businesses in the recent Senate and House GOP tax proposals, there’s been growing buzz about a more “minor” provision in the Senate Tax Cuts and Jobs Act (TCJA) proposal that could have a significant impact on financial advisors: a new requirement that any time investors sell a partial lot of existing securities, they must use the FIFO (first-in-first-out) method to determine which shares were sold and the associated cost basis (although mutual fund investors would still be able to use average cost). By contrast, under current law, FIFO is the default cost basis election, but investors still have the option to identify specific lots that are sold (at the time of sale), in order to cherry pick the most favorable shares (most commonly, by choosing the shares that have the highest cost basis and therefore will trigger the smallest capital gain or the largest capital loss). With the new rule, it wouldn’t be feasible to choose specific lots; instead, investors would always have to choose the oldest shares, which is problematic because the first-purchased and longest-owned shares tend to also be the ones with the lowest cost basis and the largest gains, while more recently purchased shares are more likely to have a higher cost basis and losses in a market pullback. Which means the investor would be unable to engage in tax loss harvesting of the more recent shares at a loss, as the FIFO rule would require them to sell the oldest shares with gains first; it would also be more challenging for tax-managed mutual funds to limit their capital gains distributions, when specific lot identification is no longer an option, although a proposed carve-out would exempt mutual funds from the treatment. And notably, the proposal would also impact which shares are selected when gifting stock, or contributing (appreciated) securities to a charity or donor-advised fund (although given that charitable donations of securities tend to work best with the most highly appreciated shares, the FIFO rule may be less problematic for charitable giving). Of course, the rule is a moot point in situations where an investor sells an entire position; identifying lots isn’t necessary if the entire position is sold at once, nor is it relevant if the entire position is bought at once (which means all the shares will have the same cost basis anyway). And it remains to be seen whether the FIFO provision will be included in the final legislation once reconciled with the House version (which does not have the FIFO rule), not to mention the uncertainty about whether the TCJA legislation will pass at all. Nonetheless, given that this is not the first time mandatory FIFO treatment has been proposed – it was also included in President Obama’s Treasury Greenbook budget proposals back in 2014 – it may only be a matter of time before the specific lot identification method is eliminated.
The Military Is Overhauling Its Retirement Systems (Ann Carrns, New York Times) – Beginning in January of 2018, the military is switching from a traditional pension based on compensation and years of service, to a new “blended” system that combines the military pension with government contributions to a defined contribution plan account (the government’s Thrift Savings Plan [TSP]). The impetus for the change is that under the current system, the military pension isn’t vested until someone has at least 20 years of service – thus also sometimes referred to as a “20 or nothing” program – yet the reality is that more than 80% of service members leave the military short of the 20-year minimum. Accordingly, the new system will offer a pension that is 20% smaller, but service members will also receive contributions of 1% of their pay into their TSP account (with the ability to earn a match of up to 4%) in addition to any TSP contributions they make themselves, and a new midcareer bonus (to ameliorate the impact of the prior 20-or-nothing rule). Notably, the new system will also give those who reach the 20-year pension threshold the option to convert a portion of their pension into a lump sum instead. The new system will apply automatically to those who enlist in the armed forces after December 31st of 2017, while those with 12-or-more years of service by the end of this year will be grandfathered into the current system; however, those who are currently enlisted (or officers who are commissioned) but with less than 12 years of service must decide (irrevocably) whether to stay in the current system, or switch to the new one. The switch will almost certainly be better for those who don’t expect to stay in the military for 20 years (as under the old system they wouldn’t get any military contributions), especially if they’re also ready to save and maximize the military match, while those who plan to stay may prefer the old/current system (with the caveat that if life changes and they can’t stay, the 20-or-nothing rule could adversely impact them later). And the Department of Defense has published a calculator tool to help make comparisons. Ultimately, those eligible for the switch will have the entirety of 2018 to make the decision to switch (though those who wait won’t get military contributions to their TSP in early 2018 before they actually make the change).
2017 Client Holiday Gift Guide (Amanda Chase, Horsesmouth) – Many financial advisors give gifts throughout the year as “thank-yous” for client referrals, the end of the year is the holiday season, and the time for giving holiday gifts to clients. Many advisors simply send holiday cards, or give “traditional” gifts like baskets of fruit or popcorn. Horsesmouth gives some suggestions on alternative (and more creative) gifts, including: give something that evokes local charm (e.g., food associated with your area like maple syrup if you’re in Vermont or peanuts in Virginia, or tickets to a local event, or even a subscription to a local magazine); work in a charitable angle, either by giving to a charity directly in the name of your clients (popular options include the United Way or Save the Children, or you can choose a local charity), or consider a gift with an organization that also has a charitable angle (for instance, WeWood sells wooden watches and plants a tree with every purchase, Hand in Hand sells soaps and donates soap and clean water for a month to a child in need, and Better World Books donates a book each time you buy a book); or if you really want to connect more personally with clients, consider something homemade (which might be your own handicraft or baking, although you can also learn how to make homemade soaps or candles, make one of these “gift-in-a-jar” ideas, create your own custom blended tea, or even design your own wine label!); give away a good book or magazine subscription (which might be a locally relevant book or magazine, or one of your personal favorites, or something perennially popular that fits in the context of personal financial advice such as Jim Stovall’s “The Ultimate Gift”, Napoleon Hill’s “Think And Grow Rich”, Pat Dorsey’s “The Little Book That Builds Wealth”, or T. Harv Eker’s “Secrets Of The Millionaire Mind”; give away some kind of Christmas or holiday décor (e.g., holiday wreaths, Poinsettias from 1-800-Flowers, or a personalized ornament or other decoration); give good food (e.g., Godiva chocolates, See’s Candies, Omaha Steaks, or Edible Arrangements); or give something that ties back to the industry (from Wall Street themed gifts, to company-branded clothing or other goods, or something personalized from ThingsRemembered). Although arguably, the best holiday gift is something truly specific to the client’s particular interests, which might be anything from a technology accessory for the tech-inclined, or related to a hobby (from gardening to a beer-brewing kit), golf accessories or other sports paraphernalia, etc.
Charging What You’re Worth: Discussing Advisory Fees With Your Clients (Kris Pettit, Cetera) – One of the most fundamental challenges as an independent financial advisor is setting a price on the value of your advice (and your time), in a world where compensation isn’t just fixed by the level of commissions that product manufacturers declare. Nonetheless, standardizing your advisory fee structure is a good business practice anyway, which Pettit suggests pursuing by backing into a target value of your time based on your goal for how much you want to earn, the number of clients you will serve, and the amount of time you will spend for each client, which ultimately rolls up to determine the amount of revenue per hour (or revenue per client based on an AUM fee) that you must generate. In other words, determine what you want/need to earn, and then evaluate whether the service you’re offering is commensurate with your fee (and if not, adjust accordingly). For existing advisors, the next step is to review your current fees with all of your clients, and evaluate whether you need to make any adjustments (either adjusting fees to match your schedule, or adjusting services to be commensurate with the fees they’re actually paying). Recognizing that these conversations with clients may still be hard when the time comes, Pettit suggests trying to figure out in advance what the likely client objectives will be, and then write down what your responses will be (ideally with a range of strategies, as some clients may respond well to a logical explanation of why your fees are changing, while others may be more persuaded by a story that gives it further context). And when the time comes for the conversations… start with the “low-hanging fruit” of your best clients with whom you have the best relationship, who are most likely to agree with the value you provide and say “yes” to any changes you propose, as it’s easier to complete the change for all clients when you start out with good momentum. Notably, the conversation about raising fees is also a good opportunity to remind clients of all the services you actually provide for your fees, both to reinforce your value, and because some clients may not even realize the breadth of your current services!
Pricing For Growth In Wealth Management (Matthew Jackson & Wei Ke, Simon Kucher) – Most comprehensive financial planners either have a standard financial planning service/solution they offer to all clients; the actual plan itself is customized to the individual client, but there’s typically only one choice for the consumer (to buy the comprehensive financial plan, or not). Or to the extent that the advisor does have a range of solution, they’re segmented by the client’s wealth and ability to pay; in other words, clients who can afford to pay more get more service, while those who can’t get less, but at no point do clients actually get the choice about which tier they will receive. Yet in most other industries, it’s standard for consumers to have a wider range of choices, including and especially for those who are more affluent may be able to afford to pay for more service or a more comprehensive solution but don’t necessarily choose to do so in all cases (e.g., not all billionaires actually drive a Bentley just because they can afford one). Or stated more simply, most advisors try to figure out “what can I [afford] to do for clients?”, instead of asking “what do clients want [and what are they willing to pay for it]?” And the problem is exacerbated by the AUM model, which doesn’t give clients pricing options based on their actual complexity and level of service needs. So what’s the alternative? Jackson and Ke advocate a form of “Value-Based Pricing” instead, where clients receive a menu or range of services that they can choose from, priced based on the value of the service for the target client (not just the cost of the advisor to deliver it). An added benefit is that by more directly tying fees to specific services (from a range of available services), it’s easier to connect the fee to the value itself – as contrasted with the AUM model, where the “value” may be a wide range of financial advice, but the fee is tied to the portfolio (which risks making clients fixate disproportionately on just the investment returns). Thus, clients might still pay an AUM fee for investment management… but a smaller fee, that is supplemented by a one-time fee for upfront planning, and a monthly or quarterly retainer fee for ongoing advice. In addition, Jackson and Ke suggest that within a particular pricing model, there should also be varying tiers of services – for instance, a smaller one-off fee for limited needs, and a higher one-time fee for those who truly want and need comprehensive financial planning advice. Though notably, a wider range of advisory fee options also means that financial advisors will have to spend more time considering how to present the range of choices as well.
The Strategy Wheel For Clarifying How To Market Your Business And Value (Gail Graham, Financial Advisor) – In order to effectively market and communicate your value to clients, it’s first necessary to get clear on your organization’s core strategy in the first place. Graham advocates breaking down strategy discussions into four core areas: Culture, Operations, Structure, and the Strategy itself. The starting point is simply to reflect “why are you in this business”, who do you serve, and what can you (realistically) do better than your competitors? Do you even know – and have agreement across all the partners – about what you want your core business strategy to be? From there, revisit your business structure, and whether you’re really positioned to deliver on your strategy; for instance, if your hallmark will be “superior service” or the “client experience”, is there someone in the firm designated with the authority to enforce that the firm delivers consistently in these areas? When there’s a conflict or disagreement about implementing the strategy, is it clear who makes the final decision? Similarly, even if you have the strategy and the leadership structure, do you have operational processes in place to actually deliver your value in a manner that is consistent with your strategy; for instance, if you focus on service, do you have clear service standards that can be consistently executed to deliver on that great service? And do you have a mechanism to actually measure it? And is your firm’s culture strong enough to ensure that these standard are maintained even if you as the business owner aren’t there to oversee it? The key point to all of this, in the context of marketing, is that most advisory firms struggle to market effectively not because it’s difficult to market, per se, but because their strategy, structure, operations, and culture are all so inconsistent, that it’s impossible to figure out a differentiated message to market (and even if the firm tried, inconsistent delivery would limit any word-of-mouth growth anyway).
From Style To Substance (Mark Tibergien, Investment Advisor) – Historically, virtually all advisory practices were “lifestyle” practices, where the advisory firm was built around the advisor’s personal lifestyle… which meant few staff and little need to run as a real “business” beyond growing to reach an economically viable size that could sustain the advisor’s personal financial needs (at which point the practice usually stopped growing altogether). In recent years, though, we’ve seen the rise of the “enduring advisory firm”, an advisory business that grows beyond the scope of just the founding advisor, and can sustain beyond his/her own time in the business… and in the process, will develop a depth of leadership, career paths for development, and a systematic means of growing the business and serving those clients. The transition has been marked by a series of major evolutionary stages over the past several decades, from the death of fixed-rate commissions in the 1970s that shifted the brokerage business model and ultimately opened the door to independent broker-dealers, to the rise of RIAs in the 1990s, and the shift to the fee-based model over the past decade, as the rise of the recurring revenue AUM model is what made it possible for lifestyle practices to compound to a large enough size to merit becoming an “enduring” firm. Though notably, Tibergien suggests that the lifestyle practice probably won’t disappear, as some advisors will continue to find the model appealing, especially those who don’t want to manage people, feel the pressure to grow, or have to take time away from clients to work on the business itself. The caveat, though, is that lifestyle firms will struggle to sell for much value, as the very nature of being a founder-centric lifestyle practice means there isn’t much value to the practice beyond the owner. On the other hand, growing an enduring advisory firm in an ever-more-competitive landscape is a real challenge as well, from competitive pressures on margins, to difficulties in differentiation, and the struggle to achieve sufficient size to gain real economies of scale, while managing client capacity amidst a shortage of young advisor talent!
What Is My Practice Worth? What You Need To Know About Value And Valuation (Ryan Grau, Journal of Financial Planning) – For financial advisors who spend their lifetimes building the value of their advisory business, the stakes are high for getting it “right” when it comes to the valuation of the business they may someday sell. However, the reality is that determining the appropriate value for a small closely-held business is not a simple thing, the mere purpose of valuation can impact the price, as valuations for third-party sales are different than for internal sale purposes, which may, in turn, be different than the valuations if the company is being dissolved in a divorce or being reported for charitable or estate tax purposes. In addition, there are different standards for determining an “appropriate” value… for instance, the common standard of “fair market value” actually rarely applies with valuation firms (as it’s normally based on an arms’ length agreement for a full cash transaction, but in advisory firms it’s typical for a seller to remain for post-closing consulting, may have non-competes that are part of the transaction, and may even seller-finance the transaction); instead, most advisory firms are valued based on the “most probable selling price” standard, which is based on the total consideration (including cash and other terms) between a buyer and seller. And notably, even the most probable selling price standard is typically based on a full sale; further adjustments must be made for internal sales or other minority partner transactions, given the limited power attached to minority non-controlling interests. It’s also important to understand that there are different approaches to determine the most probable selling price standard – in some industries, it may be based on valuation the businesses’ assets (generally not applicable to service businesses), and in others it’s based on the business’ income (forecasting projected revenue and expenses and anticipated cash flows), while some valuations are based on looking at the actual going rate of market comparables (i.e., instead of calculating what the price “should” be based on assets or income, looking at what prices have actually occurred in other comparable market sales, with adjustments from there for relevant differences). Ultimately, the key issue is to apply the right valuation methodology, approach, and standard, based on the industry and the nature of the business, and the real purpose of the valuation.
DoL Fiduciary Rule: Challenges For RIAs Under The BICE (Fred Reish, Investment News) – The Department of Labor’s fiduciary rule will require all investment advice to retirement investors to be subject to a fiduciary duty, and presents a potentially substantial disruption to the status quo for most broker-dealers. On the other hand, many RIA firms have presumed that the rule has little or no impact on them, given that RIAs are already subject to a fiduciary duty. Yet the reality is that the Department of Labor has its own definition of fiduciary duty, and its own requirements for compliance, that are not precisely the same as an RIA’s existing fiduciary duty, such that RIAs actually do need to consider their DoL fiduciary compliance issues. The most common areas of concern include: any recommendation of a rollover to an IRA under the RIA’s management, which means the RIA must consider the services, investments, and fees and expenses the client is already paying in their current employer retirement plan (as well as his/her financial circumstances, investment objectives, needs, and risk tolerance), and should be able to document their due diligence effort; a similar obligation applies to any rollover from an outside IRA (not being managed by the RIA) to a retirement account the RIA will manage (though at least due diligence should be easier, as IRA investment information tends to be more accessible than qualified plan details about investment options and their performance and costs); and RIAs should be cognizant that recommendations which generate additional payments (from 12b-1 fees to marketing allowances, or trips and gifts, as well as revenue-sharing payments from record keepers, custodians, or other entities) are prohibited if the RIA has discretionary management of the account (though they are permitted with appropriate disclosure for non-discretionary accounts). And bear in mind that while the full DoL fiduciary rule may be delayed until July 1st of 2019, the “Impartial Conduct Standards” during the current transition period still require RIAs to honor the fiduciary intent of the DoL rule.
What Really Deters Women From Staying In The Financial Advice Profession (Sophia Bera, Investment News) – In recent years, the CFP Board has conducted research studies and focus groups to try to understand why more women are not entering the financial planning profession, noting that for some the blocking point may be a perception that financial planning is ‘math-intensive’, even though the reality is that most financial planning calculations today are done via computer. However, Bera suggests that the real obstacles for women in financial planning are the nature of the financial planning jobs that become available to them. Many of the companies hiring new (female) college graduates are insurance companies or broker-dealers, that push new (women) advisors to immediately try to sell products to their friends and family, which is a major turnoff to those who wanted to become financial planners to help people (not sell to them), and it may only be years later (if at all) that they actually learn about the opportunities in fee-only and fee-for-service financial planning. In addition, for women who are trying to maintain a work/life balance (or Millennials in general, who have been recognized as placing a higher priority on work/life balance), the lack of autonomy and flexibility in entry-level financial planning jobs is also a challenge, whether it’s limitations that make it hard to drop kids off at school and come in late, to those who want to take longer vacations (and just want to know the job will be there when they get back!), especially when they’re getting the job done in fewer or different hours anyway. And for upwardly mobile and aspirational women in particular, the bureaucracy of large advisory firms is extremely frustrating, potentially driving the best women out to other firms or other fields where they don’t feel held back by an unnecessarily arbitrary career track that sometimes waits years before allowing any face time with clients. In addition, for women who are trying to career-change into financial planning, the CFP Board’s hours-based experience requirement can also create substantial challenges, as part-timers transitioning into the industry may have to wait years to fulfill the requirement, even though recent college graduates who have an entirely back-office full-time job with no financial planning work or client face time have the entirety of their 3 years of work experience counted towards the CFP certification requirements.
Financial Therapy: Addressing Practice Concerns (John Grable, FP Performance Lab) – In recent years, there has been a growing awareness of the importance of behavioral finance, and the recognition that an individual’s dysfunctional relationship with and thoughts about money can impair their financial behaviors, leading to a rising interest in “financial therapy” to help clients work through these money challenges. For instance, helping clients gain better control of their spending is often not actually a “spending” and financial issue, per se, but a psychological issue around why they feel a need to spend, for which some level of “financial therapy” may help to resolve the issue (and ultimately improve their spending and savings habits). In fact, the Financial Therapy Association is now in the process of launching a certification in financial therapy. Yet the shift of financial planning towards providing financial therapy raises challenging questions of where to draw the line between what financial planners do versus what mental health professionals do – as on the one hand, psychologists are concerned that financial planners may engage in unlicensed therapy, but on the other hand, mental health professionals trained in therapy techniques lack critical financial knowledge to give context to the therapy they may be offering. Yet arguably, it is the integrated combination of the true – a financial therapist in the truest sense, and as a unique discipline of its own – that is best positioned to help clients with their money psychology issues. However, existing regulations for mental health professionals still require that only licensed professionals (in mental health) may make formal mental health diagnoses (although anyone can use the related assessments to understand a situation, and provide basic ‘therapy’ simply by being caring and empathetic and helpful). And State Securities laws would similarly prohibit mental health professionals from providing any kind of practical investment advice without a license as an investment adviser. Accordingly, Grable suggests that it will be especially important in the emerging realm of financial therapy to clearly define the scope of advice and treatment, and may even lead to a new form of “dual-licensed” advisors (those licensed as mental health professionals, and investment advisors). At least, until/unless financial therapy is actually recognized as its own profession, with its own legal and registration standards in the future?!
Financial Advice Industry Must Give ‘Soft Skills’ The Credit They Deserve (Kathleen Burns Kingsbury, Investment News) – Talking about money is so taboo that almost half of Americans would rather discuss death, politics, or religion, than to talk about money, and money issues contribute to 50% of first divorces (and likely contribute to the 70% of families that fail to successfully pass down wealth to future generations). And while financial advisors are often involved in such money conversations, Kingsbury notes that our training is generally lacking when it comes to the emotional side of money issues that inevitably crop up in client conversations (leading to a high turnover of financial advisors, especially after death or divorce of the original client). Yet while there is at least some growing awareness of the importance of “soft skills”, Kingsbury suggests that the entire label of “soft” skills sends the wrong message, that these are “light and fluffy” issues when in reality they’re often the weightiest (and, notably, also the ones least likely to be replaced by robo-technology!). Accordingly, perhaps it is time for a shift in the industry mindset, to really take the communication and emotional issues of money more seriously, and actually start to mandate communication skills training (e.g., as a part of university and certificate programs for financial planning), and perhaps even a shift in compensation models to recognize the importance of these skills (rather than today’s business models that are so focused on sales and business development rather than depth and expertise).
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think 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 as well.