Weekend Reading For Financial Planners (November 8–9)

"Regulatory Whiplash": Experts Say SEC Remains Vigilant – With Shifted Focus

(Tracey Longo | Financial Advisor)

Following the change in presidential administration this year, many observers expected a lighter-touch approach toward regulation of the financial advice industry. And in some ways, this has come to pass, with the Securities and Exchange Commission (SEC) in June withdrawing 14 rules proposed during the tenure of previous chair Gary Gensler, including the proposed 'outsourcing rule', proposed amendments to the SEC's Custody Rule, and a proposal regarding predictive data analytics.

However, industry experts on a panel at this week's Schwab IMPACT conference suggested that such rule withdrawals shouldn't necessarily be mistaken for a softer enforcement environment. For instance, Investment Adviser Association President and CEO Karen Barr noted that the SEC this year has already brought several cases, including examples citing breach of fiduciary duty, failure to disclose conflicts of interest, Reg S-P violations, and violations of the SEC's marketing rule. She expects to see more focus on cybersecurity, custody of digital assets, and artificial intelligence from the regulator. In addition, attorney Michelle Jacko noted that, even in the absence of regulation specific to the use of AI, the SEC will likely take a close look at how advisors are using AI and whether this use is communicated to clients and represented accurately.

In sum, while some advisory firms might have felt a sense of relief following the rapid pace of rulemaking at the SEC under Gensler, an assumption that the regulator will take a lax approach towards enforcement (particularly where client data or financial losses to clients are involved) might prove incorrect. Which suggests that the apparent slower pace of rulemaking (and a pause on some SEC exams during the ongoing government shutdown), could ultimately serve as an opportunity for firms to assess their systems and policies so that they are well-prepared the next time they face an exam.

Advisors Take Longer-Term View, More Tolerant Of Drawdowns Than Retirees: Survey

(Jennifer Lea Reed | Financial Advisor)

Financial advisors will recognize differences across their client base in terms of risk tolerance, investing time horizons, and other factors. Notably, though, there can also be significant differences in the advisor's perspective about what might be the optimal path for a client and the client's own preferences, creating room for discussion about the relevant factors.

According to a survey by Capital Group of approximately 6,000 investors and 600 advisors, advisors were more tolerant of drawdowns (willing to tolerate a 30% decline in account balances of their clients), while 65% of investors surveyed were only willing to risk a maximum 15% decline in their account balance. Also, while many investors surveyed anticipated a 20-year withdrawal period in retirement, most advisors preferred a 30-year approach (though the percentage of investors preferring to use a 30-year withdrawal period increased compared to the previous version of the survey). Given that there is no single 'right' answer to either of these questions, the potential differences between these two groups could call for open communication about the tradeoffs between the available options (e.g., securing more income in the short run versus potentially drawing down a portfolio early if a client lives longer than expected).

Digging deeper into risk tolerance, the survey found (perhaps unsurprisingly) that older clients tended to be more risk-avoidant, with 78% of retired respondents saying they would prefer to lower risk even if it meant lower returns (with only 22% preferring to pursue higher return with higher risk), compared to 54% of individuals further from retirement (46% of whom were willing to pursue higher return with higher risk). The survey also asked respondents how they are or plan to fund their retirements. Retired respondents reported getting 46% of their income from Social Security benefits and 42% from retirement accounts, while those further from retirement expect to get 31% from Social Security and 63% from retirement accounts (which could reflect decreased confidence in eventually receiving full Social Security benefits and/or a stronger propensity to save in retirement accounts).

In the end, key skills of a financial advisor include being able to determine the preferences of their clients (from their risk tolerance to goals for their retirement), educate them on concepts and tradeoffs they might not have considered, and clearly offer their own recommendations while understanding that some clients might prefer an approach the advisor might not view as optimal from a 'math' perspective.

Advisory Firms Seeking Talent Might Be Overlooking Pool Of Career Changers From Outside The Industry: Study

(Financial Advisor)

Bringing on fresh talent is an important task for growing firms as they develop the next generation of advisors and leaders at the firm. Notably, there are many ways aspiring financial planners find their way to the industry, from university financial planning programs to career changes from both inside and outside the finance industry. Which suggests that relying on one specific pool of candidates could mean that firms miss out on talented individuals from other backgrounds.

According to a study by Amplified Planning and Charles Schwab (which used survey and focus group data from participants in Amplified Planning's Externship program for newer and aspiring planners as well as data from Schwab's RIA Benchmarking Study), while RIAs are primarily recruiting from personal and professional networks, schools, and other RIAs, 38% of those in the Externship program are career changers from other industries (who might be outside current advisors' networks), while 29% are college students and 24% are current financial services professionals (suggesting that firms not intentionally seeking career changers from other fields might be missing out on this group of potentially attractive candidates).

Notably, the group of external career changers can come to the table with a set of transferrable skills gained in their previous roles (with common previous careers including education, healthcare, technology, and engineering), but can suffer from the sense of 'starting over' or feeling undervalued by their firms (who might put them in the same 'bucket' as a recent graduate, even though career changers might have significantly more real-world professional experience and skills). Another challenge for this group is the salary transition that can occur when moving from an established career to a new field (perhaps suggesting that firms seeking to tap into this talent pool might show them the path to greater compensation in their firm).

Ultimately, the key point is that at a time when many financial advisory firms are eager to bring on new talent, tapping into the broadest possible pool of candidates could help a firm find the best fit for their role and take advantage of different skillsets candidates might bring to the table. Which could ultimately lead to a smoother hiring experience and a stronger talent base within the firm!

Study Advocates For 100% Equity Portfolio For Clients Across The Age Spectrum

(Aizhan Anarkulova, Scott Cederburg, and Michael O'Doherty | SSRN)

Many investors adjust their asset allocations over time to become more conservative as they near and enter retirement (in part to protect against sequence of return risk), shifting from an equity-heavy portfolio to one with an increased allocation to bonds (before perhaps getting more aggressive later in retirement). Relatively young investors (who might have multiple decades until they retire) might choose to allocate a portion of their portfolio to bonds (perhaps as a volatility dampener) as well.

However, in an updated version of their previous research, the authors find that an all-equity portfolio (consisting of 1/3 U.S. stocks and 2/3 international developed market stocks) could be appropriate for investors across the age spectrum (with a potential exception for those in the first few years of retirement with rigid spending requirements, who might hold a small allocation of Treasury bills during this period). To reach this conclusion, the researchers analyzed stock and bond returns from 39 countries from 1890 through 2023 (using the longest available period during which each market was classified as developed, and using time-series and cross-sectional dependencies to reflect actual investor experience in a range of periods), finding that while U.S. stocks saw an inflation-adjusted average annual return of 7.74% during this period and international stocks bonds saw a 7.03% real return, bonds only returned 0.95% annually after inflation. In addition, while bonds are often included in a portfolio for diversification purposes, the authors found this benefit to be relatively muted across a 30-year time frame (particularly when considering bonds' relatively weak returns during inflationary periods), arguing that international stocks are a superior alternative for their stronger returns and ability to preserve real buying power.

In sum, while it is sometimes assumed that at least a small allocation to bonds is prudent for investors across the age spectrum, this research highlights that they could serve a drag on performance in the long run (potentially requiring individuals to save more for retirement than they would have to with an all-equity portfolio). Though ultimately, while such an all-equity approach might look good on paper, many clients might be willing to trade some long-run upside for dampened volatility in the short run, allowing advisors to offer value by creating a portfolio allocation that meets both clients' capacity and tolerance for risk.

With Only One Life To Live, Owning Bonds Could Be A Prudent Choice

(Jason Zweig | The Wall Street Journal)

Long-run data on the returns of different asset classes paint a clear picture, with stocks outperforming bonds over extended periods. Which might tempt many investors to maintain an equity-heavy asset allocation throughout their lives in order to maximize their long-run total return.

An issue, though, with relying on long-run data is that each individual only has their own personal investment period and won't necessarily receive the 'average' long-term return. This is particularly relevant for individuals who are near or entering retirement as the sequence of returns they experience can have a significant effect on whether their portfolio will be able to sustain their lifestyle needs throughout what could be a multi-decade retirement (though it's also worth noting that a positive sequence of returns could lead to significant upside in terms of portfolio-generated income and/or terminal value as well). In addition, some clients might prefer the peace of mind that comes with having a sizeable allocation to less volatile assets (even if it potentially dampens the growth of their portfolio during strong equity markets). In Zweig's case, he invests in Treasury Inflation-Protected Securities (TIPS) to get some of the inflation-hedging benefits stocks can provide with significantly lower risk (even if TIPS would be expected to underperform over the long run).

In the end, even if an equity-heavy allocation would be expected to outperform in the majority of instances, clients will have a range of perspectives on how they want to handle the (very real, if relatively lower-odds) chance that they will experience a particularly negative sequence of returns in their personal experience. Which gives financial advisors the opportunity to understand this risk perspective and craft portfolios that match their clients' goals (with the understanding that asset allocation [and client spending] isn't a one-time decision, which can provide flexibility over the course of an extended retirement).

Securing Retirement Income: What Does Certainty Cost?

(Massimo Young and Ing-Chea Ang | Advisor Perspectives)

The transition from working to retirement can be challenging for many clients, with one mental hurdle being the shift from receiving regular paychecks (and saving a portion of them) to relying on their investment portfolio to support (at least a portion of) their lifestyle. Which can lead some retirees to prefer a very conservative asset allocation to avoid significant downside volatility in their retirement years.

However, a very conservative investment approach can come at a 'cost' of lost (potential) upside from investing in riskier assets (which could ultimately limit available retirement income [in particular, real spending if the retiree experiences a period of high inflation] or a legacy interest). Notably, riskiness here is not just between asset classes but also within them (e.g., different categories of equities or bonds). For instance, Young and Ang calculate the "price of certainty" for different types of bonds in a "cash flow-matched bond strategy", where an investor looks to match the cash flows from bonds (i.e., coupons and principal at maturity) to their desired cash flows.

For instance, cash flow-matched Treasury Inflation-Protected Securities (TIPS) provide a very high level of cash flow certainty (given their minimal default risk), but come at a relatively high 'cost' (in this case, using historical data, an investor looking to spend $40,000 per year (with a 2% inflation assumption) over thirty years would need to invest $882,703 in the strategy). On the other end of the spectrum, an investor willing to invest in BBB-rated corporate bonds would have less certainty (given the default risk of these instruments), but would only have to invest $717,287 for the same result. In this way, the 'cost' of greater certainty of the strategy working is approximately $165,000 that needs to be invested in the strategy (notably, there are a variety of middle-ground options evaluated as well, including period certain annuities and higher-rated corporate bonds).

Ultimately, the key point is that the tradeoff between certainty and returns is not only a qualitative concept, but one that can be quantified as well. Which could help financial advisors give their clients a more complete picture of the 'cost' of achieving greater certainty in their retirement income approach and help them pick the best option for their unique needs and preferences.

America Is Minting Lots Of Cash-Strapped Millionaires

(Ben Steverman, Andre Tartar, and Stephanie Davidson | Bloomberg News)

The idea of being a 'millionaire' has long held sway in the imaginations of Americans, being seen as a clear numerical marker of achieving significant wealth. However, reaching millionaire status today doesn't necessarily confer the same financial advantages it might have in decades past, not only due to the effects of inflation (meaning that a million dollars today can buy much less than it did in the past) but also because the composition (and liquidity) of an individual's assets can impact how wealthy they feel (and how they might use their assets).

Using data from a U.S. Census Bureau study, the authors find that there are now 24 million households with at least $1 million in net worth in the U.S., with a third of them hitting millionaire status since 2017 amidst a strong stock market and home price growth. The problem for many of these households, though, is that much of their wealth is tied up in relatively illiquid assets, such as real estate and retirement accounts (their analysis found that for those with a net worth of $1-$2 million, 66% of their wealth was tied up in these two assets, an increase of 8 percentage points since 2017).

Which means that some of these millionaires might feel cash-poor despite their overall wealth if they have fewer dollars available in cash instruments or taxable brokerage accounts (though tapping into the latter could be challenging for some if they have significant embedded capital gains). Further, those who might want to borrow against their home equity or brokerage account balance are feeling the effects of elevated interest rates which increase the cost of doing so.

Altogether, while a net worth of a million dollars remains a significant figure (particularly at a time when many other Americans are struggling and have little in the way in terms of assets), some millionaires might feel like they are cash-strapped and unable to tap this wealth. Which suggests a valuable role for financial advisors in both helping them explore ways to achieve greater liquidity and to create a cash flow plan that matches their desire for liquidity with the ability to take advantage of tax-preferenced retirement account contributions (or a purchase of a relatively illiquid asset like a home).

On The Fence About A Spending Decision? Try The 0.01% Rule

(Joe Pinsker | The Wall Street Journal)

Even when individuals have relatively significant wealth, they can sometimes have a hard time deciding when to make a particular purchase, whether it's a working professional balancing spending and savings priorities or a hesitant retiree worried about spending down their assets. In some cases, the time cost could vastly outweigh any potential savings (e.g., spending a couple hours comparing options for a $20 product).

With this in mind, author and blogger Nick Maggiulli offers what he calls the "0.01% Rule", whereby an individual doesn't need to stress about a financial decision if it concerns 0.01% or less of their net worth (e.g., someone with a $1 million net worth wouldn't stress over a decision concerning something less than $100). The math behind the rule is that 0.01% represents about one day's worth of spending for someone following the "4% Rule" (i.e., sustainably withdrawing 4% of portfolio value per year). Notably, individuals using this rule might tailor it to their individual situations, for instance by using 0.01% of liquid net worth for those with significant dollars tied up in illiquid assets (while those who tend to splurge might limit the number of "0.01%" purchases they make in a given week).

Ultimately, the key point is that for individuals who have a hard time getting themselves to spend on items that they almost certainly can afford (or are planning to spend hours working for minimal savings), the 0.01% Rule could be a handy (if not customized) rule of thumb for worrying less about purchases and enjoying them more (and could be a helpful tip for financial advisors to offer frugal or spendthrift clients (the latter of whom might think twice before making a purchase that exceeds the limit).

Client Cash Management As A Value-Add Service For Financial Advisors

(Ben Henry-Moreland | Nerd's Eye View)

Cash tends to exist at the forefront of individuals' day-to-day lives for many reasons: as a stable savings vehicle for near-term goals, a safety net for unforeseen emergency expenses, and, of course, to pay for daily living expenses, just to name a few. And this nearness to daily life means that cash - and how it is used - is also often at the forefront of individuals' minds. In general, this means that people are more likely to be more aware of how much cash they're holding than the other numbers in their financial life, like the balances on their retirement accounts (which, being less 'immediate' in their intended purpose, are not often at the forefront of most people's minds to the same extent that cash is).

However, despite the impact that cash may have on a person's mindset, advisors have traditionally spent little time advising clients on what to do with their cash - except simply to tell them not to hold too much for risk of losing value to inflation. With recent economic changes, though, there are renewed opportunities for advisors to help clients manage their cash more effectively, with higher yields available on bank accounts, CDs, and other cash-like assets than in previous years. Which means that individuals might start earning non-trivial yields on their cash, giving advisors an opportunity to add value in new ways by advising clients on the questions of how much cash to hold and where to keep it!

While high-yield savings accounts at online banks have been a popular place for storing cash for the last decade, in more recent years the FinTech world has developed more options that could create more value for advisors and their clients. One example is cash management accounts developed by digitally-focused broker-dealers and robo-advisors, which while similar to savings accounts from a customer's perspective, provide key features (like higher FDIC coverage limits and a streamlined experience with the customer's existing investment accounts) that distinguish them from traditional savings accounts.

Though many of these accounts exist primarily to serve retail customers of broker-dealers and robo-advisors (which might make advisors hesitant to recommend them for fear of introducing customers to a potential competitor), there are also multiple options for cash management accounts developed solely for clients of financial advisors. With these options, advisors can offer a cash management service within the rest of their financial planning 'ecosystem', offering competitive yields on cash and FDIC coverage limits of up to $25 million, without having to send clients out to other financial institutions that might want to lure them away from the advisor!

Ultimately, the key point is that while the current economic environment provides a particular opportunity to focus on cash management, the reality is that the value of cash management can be ongoing despite the ebb and flow of economic conditions. For advisors looking to be paid directly for this value, a small, flat cash-management fee might be feasible without eating up too much of the yield on clients' cash. However, in most cases, cash management may actually be a worthwhile 'free' service – both only as a differentiator for prospects, but also as a way to renew existing client relationships and continually provide ongoing value!

Why AI Will Never Defeat Primal Intelligence

(Angus Fletcher | Next Big Idea Club)

Recent advances in Artificial Intelligence (AI) have led to speculation about the skills that will be valuable in a world with computer systems that can process information and complete certain tasks more efficiently than humans.

With this in mind, Fletcher studied visionary thinkers and U.S. Army Special Operators to find areas where humans might continue to outperform AI for the foreseeable future. One key area of human superiority is in dealing with volatile situations with incomplete (or no) prior information. While AI tools struggled in situations where they didn't have relevant training data, Special Operators outperformed in part based on their ability for narrative cognition, or thinking in story. While the Special Operators might not have had all the facts they needed, they could tell a story based on what they saw and help them make it through the situation.

Another area of potential human superiority concerns intuition, or the ability to anticipate the future faster than others. Those with strong intuition tend to be skilled at identifying exceptional information, or an exception to a previously established rule. While children tend to score high on intuition (given their brains are focused more on unusual details than on familiar patterns), adults can build this skill as well, through travel (by breaking the pattern of regular life) or by reading stories that break from conventional patterns (e.g., many inventors and creators have been avid readers of Shakespeare, who often included characters who are exceptions to conventional narrative formulas).

In sum, while AI tools might be able to perform a broader array of tasks in the coming years, humans could still hold an advantage in certain areas, particularly around uncertainty and intuition. Which suggests that strengthening those skills (in addition to communication skills that AI tools might not be able to match) could help workers continue to thrive in the years ahead (whether on a standalone basis or alongside AI tools).

When Working With AI, Act Like A Decision-Maker – Not A Tool-User

(Cheryl Strauss Einhorn | Harvard Business Review)

The current generation of Large Language Models (LLMs) can be impressive in their ability to generate polished text quickly in response to a user prompt. For instance, a financial advisor might ask ChatGPT or a similar tool to draft an email response to a client or perhaps a blog post to be used for marketing purposes.

Given the seemingly high-quality nature of LLM output, it could be tempting for an advisor to use it directly with minimal or no editing. However, doing so might lead to outputs that, while seemingly sensible on their face, might not be as high quality as the advisor could produce themselves. With this in mind, Einhorn suggests four "anchors" individuals can use when making decisions based on LLM output.

The first "anchor" is an authority check, ensuring that the LLM actually created the desired output and that it matches the desired tone, nuance, and context. Next, a purpose check ensures that the LLM output actually represents the user's own short- and long-term goals (given that it won't know a particular individual's motivations, instead using crowdsourced wisdom). The third "anchor" is an accountability check, where a user determines whether they stand behind the information and are comfortable defending the viewpoint (which could be a particularly valuable step for advisors using AI notetaking tools that might not accurately gauge nuances during client meetings). Finally, with a truth check, the user might question whether the output might be wrong and check whether the information is verifiable.

Ultimately, the key point is that while LLMs can produce impressive outputs, it remains important for advisors and other users to leverage their own knowledge and abilities to ensure that they're driving decisions using LLMs for support, rather than taking these outputs at face value.

What AI Companions Are Missing

(Adam Grant | Granted)

Financial advisors might use AI tools for a variety of functions, from drafting text to conducting research (or, on a personal level, perhaps getting recipe or travel suggestions). For some teenagers and others, though, AI chatbots have become valued companions with whom they share information (and spend significant amounts of time), a one survey finding that 72% of teens have used AI companions, with nearly a third finding them as satisfying or more satisfying than human interaction.

While 'talking' with an AI chatbot might be helpful in some situations (e.g., being able to roleplay a potentially awkward situation before actually doing it in person), a potential issue is that these interactions are one-sided, with the chatbot providing (hopefully) valuable responses to the user, but the user being unable to add value for the chatbot. This stands in stark contrast to human relationships, where friends or family members offer mutual benefit to each other through words or acts. Grant suggests that while such interactions with chatbots might seem fulfilling in the moment (e.g., chatbots often will tell users what they want to hear), reliance on them for social 'interaction' could provide a loss of meaning that comes from supporting others (whether a person, pet, or even a plant).

Altogether, while a relationship with another person might be more complicated than one with a chatbot (where the user can control the boundaries of the interaction), the mutual nature of human relationships can make them more fulfilling and, ultimately, lead to a greater sense of purpose in life that a chatbot might be unlikely to match.

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

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