Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the big news that a majority stake in mega-RIA Edelman Financial has been purchased by private equity firm Hellman & Friedman at a whopping $800M valuation, a market valuation that may have been upwards of 3X the $15B RIA’s revenue, suggesting that the big money still sees a bright future for RIAs charging AUM fees. Also in the news this week was a final rule from FINRA that will require brokerage firms to include a link to FINRA’s BrokerCheck system so consumers can more easily investigate the regulatory history of their brokers… though, sadly, the rule will not require brokers to provide consumers with a link directly to their actual BrokerCheck profile!
From there, we have a few technical planning articles this week, including: a discussion of the new DFA-based ETFs being offered by John Hancock and how they differ from DFA’s traditional mutual funds; a new study raising the question of whether high-deductible health plans paired with health savings accounts are just leading consumers to skip out on important health care services (rather than becoming more savvy health care shoppers); guidance on why advisors might want to work with clients to reconstruct the total amount of non-deductible contributions into their IRAs if they haven’t already been tracking it on Form 8606; and a recent Supreme Court ruling that opens the door for clients with income taxed by cities and counties across multiple states to file amended tax returns and claim a refund for the past 3 years.
We also have a couple of practice management articles, from a discussion of how the proposed DOL fiduciary rule could introduce significant paperwork and compliance obligations for RIAs as well as broker-dealer firms (for any RIA whose AUM fee is higher than the prospective client’s former 401(k) plan), to a look at why it’s so crucial to establish clear and consistent messaging about the services an advisory firm provides to its clients, and a reminder that if advisors are going to claim to be the “quarterback” of the client’s financial team that they really need to step up and actually be the quarterback that proactively reaches out to and engages with a client’s other advisors!
We wrap up with three interesting articles: the first raises the question of whether female-focused advisory firms, like Sallie Krawcheck’s recent Ellevest initiative, are really likely to succeed, especially given that several prior high-profile initiatives in the past decade have all quietly folded (or whether the reality is that focused on “women” is still far to broad to be a relevant ‘niche’ solution); the second is a critique of the recent Elite Daily article that Millennials should just enjoy themselves in their 20s and not worry about savings, pointing out that our 20s are often the best time to work hard and set our careers on a path to success; and the last is a touching offering of financial advice from personal finance writer Morgan Housel to his newborn son, that provides good relevance reminders for anyone and everyone (regardless of age)!
And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end, including why Winterberg is upbeat on the Morningstar acquisition of Total Rebalance Expert (tRx), the announcement that LogMeIn has acquired LastPass, and coverage of the recent LaserApp “AdvisorCon” conference.
Enjoy the reading!
Weekend reading for October 17th/18th:
Why The PE That Helped Take LPL Public Now Controls Edelman Financial (Lisa Shidler, RIABiz) – Back in 2012, Lee Equity Partners took Edelman Financial private at a valuation of $265M, and this week it was announced that another private equity firm, Hellman & Friedman, has purchased Lee’s share in a deal that the Wall Street Journal reports was valued at a whopping $800M. Over this time period, Edelman’s core business grew its AUM from $8B to almost $15B, which suggests that the firm’s valuation multiples have only improved as the business has grown (possibly as much as 3X revenue or more!), which some are interpreting as a positive overall sign for expanding RIA valuations. And notably, with 28,000 clients, the average Edelman client is a mass affluent investor with $536k of AUM, not a high-net-worth investor, suggesting that there is still ample room for RIAs to serve the mass affluent profitably. Also notable is that while some have raised the question of whether the deal was a means for Edelman to ‘cash out’, the transaction was actually Hellman purchasing Lee Equity’s share (not Edelman’s), and in fact Hellman is widely known as the firm that invested heavily into LPL in 2005 during the heavy growth years that ultimately led to its public IPO. Which means ultimately Edelman’s firm may ultimately be on the same IPO path (though Edelman has not indicated any plans for it in the near future). At the same time, questions abound as to whether Edelman can successfully institutionalize the “Edelman” brand and remove himself from the equation (as Charles Schwab eventually did), especially after David Bach (once anticipated to be Edelman’s heir apparent successor) left the firm earlier this year. Nonetheless, Edelman notes that he anticipates Hellman’s investment will allow for the firm to reinvest further and grow even faster than it has in the past.
SEC Approves Rule Requiring BrokerCheck Links (Mark Schoeff, Investment News) – After being first proposed in January 2013 and subsequently withdrawn and modified twice, FINRA has finally approved a rule that will require brokerage firms to include a link on their websites to the public BrokerCheck database. Under the new rule, which must be published in the Federal Register by December 7th and will take effect no more than 180 days later, a brokerage firm will have to include a “readily apparent reference and hyperlink”on their websites to the BrokerCheck home page. Profile pages of individual brokers will also have to include links to BrokerCheck. Notably, though, a key aspect of the prior version of the proposal, requiring the links to go directly to a broker’s profile on BrokerCheck, was not approved; instead, all links will merely go to the BrokerCheck home page, and the consumer must still take additional steps to look up their broker. The final rule also does not include prior proposals that advisor social media profiles would need to link to BrokerCheck; instead, the BrokerCheck link will only be required on the brokerage firm’s website. Ultimately, though, the SEC notes that it will continue to monitor investor awareness of BrokerCheck and may pursue further rulemaking in the future if consumers are still not utilizing the platform.
A Closer Look at the New John Hancock ETFs Based On DFA Funds (Alex Bryan, Morningstar) – Last month, John Hancock made its first foray into offering exchange-traded funds, by launching six ETFs based on DFA (Dimensional Fund Advisors) indexes. And what’s notable about these “DFA ETFs” is that they’re available to anyone who wishes to buy them (unlike DFA’s mutual funds, which are only available to individual investors through an approved financial advisor or certain 401(k) platforms). The flagship ETF is the John Hancock Multifactor Large Cap ETF (JHML), which tracks the index employed by the DFA US Core Equity (DFEOX) Fund, and is designed to give broad market exposure but with an overweight to certain factors that have been associated with higher long-term returns, including value stocks, small cap stocks, and companies with greater profitability. Other offerings in the ETF lineup include a mid-cap ETF (JHMM), and four sector ETFs (in Consumer Discretionary [JHMC], Healthcare [JHMH], Financials [JHMF], and Technology [JHMT]), all of which apply a similar factor weighting approach in their respective areas. Notably, because the ETFs employ DFA’s underlying proprietary “indexes”, they should benefit from DFA’s approach to index construction, including the ways that it will make small adjustments to stock allocations and substitute stocks in certain situations to keep turnover and transaction costs lower. Ultimately, Morningstar notes that accessing DFA’s funds through the ETF wrapper may be even more tax-efficient than its mutual funds, as even though DFA manages in a fairly tax-efficient manner, its funds do make capital gains distributions from time to time (while the ETFs will likely avoid this altogether, given their ability to transfer out low-cost-basis shares through in-kind transactions with authorized participants). On the other hand, the new ETFs charge a higher expense ratio than their mutual fund counterparts (0.35% vs 0.19%, respectively), and at least for now are thinly traded (which could create problematic ETF bid/ask spreads from time to time). Of course, if the new DFA/Hancock ETS become more popular, bid/ask spreads should narrow, but it remains to be seen how popular the DFA multifactor ETFs can really become amidst an already crowded marketplace of multifactor and “smart beta” ETFs.
This Study Is Forcing Economists To Rethink High-Deductible Health Insurance (Sarah Kliff, Vox) – In 2006 only about 10% of employees had a health insurance deductible over $1,000, but now it’s nearly 50%. Of course, in theory this was supposed to be “good” news, as health economists have long believed that if patients were more responsible for their health care costs, they would become smarter shoppers, which in turn would force expensive and overpriced health care providers to lower their prices in line with their lower-cost competition. Yet in a new NBER paper entitled “What Does a Deductible Do? The Impact of Cost-Sharing on Health Care Prices, Quantities, and Spending Dynamics” by Zarek Brot-Goldberg, Amitabh Chandra, Benjamin Handel, and Jonathan Kolstad, the authors studied a firm that in 2013 shifted tens of thousands of workers into high-deductible health plans to see how their patterns of care changed. And what they found was that with higher deductibles, patients didn’t shop for better deals, they simply used far less in health care services – both the healthy and sick patients. This is concerning, particularly regarding the sick patients, because it implies that those with health issues may end out just waiting and allowing health conditions to deteriorate, which in the long run is both damaging to their health itself and can be even more expensive for the health care system in the aggregate. And notably, the drop occurred even though the employer provided a $3,750 contribution to a Health Savings Account for the workers to cover their new $3,750 deductible; in other words, the net cost of the deductible to employees didn’t rise, but they still became less effective consumers of health care services, cutting back on both potentially wasteful care (e.g., unnecessary imaging services) but also potentially valuable care (e.g., preventive visits), and the sickest patients were the ones who reduced health care utilization the most. Notably, questions still abound about why exactly the health plan participants cut back so much, even on health care services they “should” have been using, which means the NBER study will likely be followed by others who study the issue further to try to determine whether high-deductible health plans simply need to be structured differently, or if there’s a more substantive issue to be addressed.
Sidestep a Tax Hit by Reconstructing IRA Basis (Ed Slott, Financial Planning) – When investors make a non-deductible contribution to an IRA, subsequent distributions of those “after-tax” contributions are treated as a tax-free return of principal, with the share of after-tax distributions determined on a pro-rata basis aggregated across all of the individual’s IRAs. Normally, these non-deductible contributions are reported to the IRS on Form 8606, but sometimes people fail to do the proper tax reporting to substantiate the after-tax dollars inside their retirement accounts (which is unfortunate, as it would lead to those amounts being double-taxed, once when they were originally contributed, and again upon subsequent withdrawal!). In a recent Tax Court case (Gustavo E. Morles v Commissioner, T.C. Summary Opinion 2015-13, Feb 23 2015), though, the courts permitted an investor to claim the favorable treatment of after-tax distributions even though they were never properly reported in the first place (and the IRA custodian originally reported the distribution as fully taxable on Form 1099-R). The key was that the taxpayer, Morles, could substantiate through other documentation that his contribution had been after-tax (e.g., by noting that it was not deducted on his prior tax return), and the Tax Court acknowledged that the Internal Revenue Code doesn’t actually require that basis initially be reported correctly in order to be claimed later (though obviously there must still be some means to substantiate it). Given this ruling, Slott notes that if advisors have any clients who might have made non-deductible IRA contributions it the past, it may be worthwhile to try to reconstruct that after-tax “cost basis” of the IRA now, through checking prior IRA statements for contributions, prior year Form 5498s that would show the contribution, and prior-year tax returns to see if there were any IRA contributions that were not actually deducted at the time (but don’t bother going further back than 1987, which was the first year non-deductible IRA contributions were permitted). If prior basis is found and can be substantiated, file a Form 8606 for the current year to bring the non-deductible contributions reporting up to date, so the IRS will be less likely to question it in the future (but keep the documentation you found to substantiate it, too!).
Supreme Court Opens Door to Rare Tax Refund Opportunity (Randy Gardner & Leslie Daff, Journal of Financial Planning) – Earlier this year in the case of the Comptroller of the Treasury of Maryland vs Wynne, the Supreme Court declared that having the same income taxed twice by two or more political subdivisions violates the commerce clause of the U.S. Constitution. In the Wynne’s case, this was because they were owners of a Maryland S corporation that did business in multiple other states, and while Maryland allowed its residents to claim a state income tax credit for the taxes paid in other non-resident states, the local Maryland county tax did not allow such a credit, resulting in other-state income being double-taxed by both Howard County Maryland (where the S corporation was based) and other states (where the S corporation did business). The outcome of the ruling for the Wynnes was that Howard County had to go ahead and grant a tax credit for taxes paid in other states against the local county tax liability, but Gardner and Daff point out that the ruling opens the door for anyone who has been subjected to such a situation to go ahead and file a claim for refund as well. Common situations will include either scenarios where a resident state didn’t allow a tax credit for taxes paid to other non-resident cities and counties, or situations like the Wynnes where the resident city/county didn’t allow a tax credit for non-resident state taxes paid. Amended returns could be filed to claim a refund for the 3 prior tax years that are still open (2012, 2013, and 2014), potentially for anyone who had multi-state income that included the certain cities/counties in the states of Alabama, Arkansas, California, Colorado, Delaware, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan, Missouri, New Jersey, New York, Ohio, Oregon, Pennsylvania, West Virginia, and the District of Columbia (the article includes details about which cities/counties in those states may qualify). The tax refunds may be especially significant for those who have heavy income earnings across a large number of jurisdictions, such as professional athletes and performers, and many of these states are expected to issue updated guidance about how taxpayers should pursue tax refunds and file their taxes differently (to claim the newly-approved credits) in the future.
RIA Rollover Advice Could Fall Under DOL Rule (Dan Jamieson, Financial Advisor) – While already-fiduciary RIAs have been strong supporters of the Department of Labor’s proposed fiduciary rule, and its “Best Interest Contract” (BIC) requirement that would apply to brokers involved in rollovers, experts note that RIAs themselves may be subject to some of the new BIC paperwork and disclosure requirements as well. The issue arises for any RIA that recommends a rollover where the RIA’s fees are higher than the original retirement plan’s; even if the higher fees cover extra advice services the advisor offers, the presence of a higher fee will still force RIAs to go through the entire BIC process with prospective clients (including having prospects sign the contract itself, along with providing them extensive point-of-sale and subsequent disclosures), or face Department of Labor penalties for engaging in a prohibited transaction. The rule will also apply to any RIAs who have revenue-sharing deals or get marketing allowances from product sponsors or custodians. In fact, technically the Best Interest Contract exemption to allow advisor rollovers that will have a higher cost (ostensibly for additional services) is only permitted for non-discretionary fee-based accounts, and rolling over to an outright discretionary account would be an outright prohibited transaction (which could prevent RIAs from handling rollovers altogether), although pro-RIA lobbying groups have requested that this issue be clarified/resolved when the DOL issues its final rule proposal next year (potentially with a separate exemption specifically for already-fiduciary RIAs charging level AUM fees, as the Financial Planning Coalition suggested in their DOL comment letter). Ultimately, the final rule – including detail about whether and how it will apply to RIAs – is due out in the first half of 2016.
8 Benefits of Clear, Consistent Messaging (Angie Herbers, Investment Advisor) – Earlier this year, Herbers’ practice management consulting firm Kaleido launched an online evaluation tool for financial advisors called the Kaleido Scope, which evaluates advisory firms across a wide range of areas to help them diagnose areas in which they may need help. Yet after evaluating 163 firms in the past 6 months, Herbers notes that the aggregate results are also providing an interesting perspective on the broad-based challenges that all advisory firms are facing. For instance, while advisory firms continue to have incredibly high retention rates (with many losing no more than 2% of clients per year), those same firms have very low referral rates of only 23%/year, and closing rates of only 50%. Herbers suggests that declining referral and close rates are a result of advisory firm owners overreacted to the current competitive environment, and are making knee-jerk reactions like considering whether to switch away from AUM fees or adopt alternative revenue models, that are just confusing in the minds of their clients what the firm does and who should be referred (so clients respond by not referring at all). Instead, Herbers suggests that firms need to (re-)focus their energies on what makes them truly unique, and stick to the essential services that they are best at delivering, which ultimately helps firms more easily train advisors and employees (because everyone is clear about what the firm does for clients), improves morale, and helps the firm grow with clearer messaging to clients and prospects and an easier process of crafting a marketing plan. Herbers’ firm offers its own tool to help advisors think through this process, called X-Cell.
What It [Really] Takes To Be The Quarterback Of Your Client’s Team (Steve Wershing, The Client Driven Practice) – While many financial advisors like to describe themselves as “the quarterback” of the client’s financial team, and market research suggests that clients really do welcome an advisor who can serve as that quarterback, Wershing notes that what many advisors deliver in practice does not live up to the promise, or at least not on a consistent basis. Instead the advisor may act as a quarterback for some clients but not others, or may only reach out to affiliated professionals reactively when the need arises, rather than proactively to coordinate on planning issues. So what should the quarterbacking process really look like? Wershing suggests the following key areas: 1) the firm must really offer financial planning in the first place (if you specialize in just investment management, you probably don’t have the breadth of knowledge and interaction to be the quarterback in the first place, and instead should be the [investment] specialist that works with someone else as the quarterback!); 2) have a formal process for reaching out to coordinate with other advisors (e.g., systematically touch base with all client accountants in the spring for an annual tax planning process); 3) be consistent in outreach and follow-through with other professionals; 4) have a solid network of people you can refer the client to in the first place (if you want to really be the quarterback, you need to be able to send clients to someone who can solve their problems if their current experts are not sufficient); 5) have a client vault (or some other organizer) of documents that can easily be shared in coordination with other advisors; and 6) have a structured process to initiate formal meetings with a client’s other advisors whenever a new client joins your firm (to establish the quarterback relationship and demonstrate/clarify your role to the new client and his/her other advisors).
Financial Advice Just for Women Might Seem Like a Great Idea, But Here’s Why It’s Not (Helaine Olen, Slate) – Earlier this month, former Wall Street executive Sallie Krawcheck (one of the few women to ever ascend to the top ranks at a Wall Street firm) announced that she had raised $10M of funding to open up her own female-focused advisory firm, called Ellevest. Arguably there is a significant need for a women-centric advisory firm, given industry research that has found the traditionally male-centric industry does an especially poor job serving female clients, from more aggressive sales tactics to condescending attitudes and more. Yet female-focused firms have not had much success; an initiative from Charles Schwab specifically targeting women several years ago was folder into a more generalized financial literacy program, Citibank’s Women & Co initiative folder recently, and Alexa Von Tobel’s women-centric LearnVest platform still ultimately gathered fewer than 10,000 customers willing to pay for its relatively low cost financial planning advice when it was sold to Northwestern Mutual. And ultimately, Olen notes that many of the financial challenges that women face ultimately stem from broader societal issues, from the gender gap of unequal pay to lopsided caretaking burdens of family, that can’t be resolved by individual financial advice alone. Beyond that, the reality is that “specializing” in 50% of the population isn’t really that targeted of a ‘niche’ service anyway, so it’s not clear whether or how Ellevest will be able to focus enough to have any real success in attracting female clients. Of course, Krawcheck already purchased a 34,000 member women’s networking group (originally called 85 Broads, now dubbed Ellevate) a few years ago, and therefore has a native audience to which Ellevest can be rolled out… but it remains to be seen whether the new initiative will fare any better than prior efforts that have had only limited success at best.
If You’re Not Getting Rich in your 20s, You’re Doing it Wrong (Mr. Money Mustache) – A few weeks ago, a publication called Elite Daily released an article that quickly went viral (now with over 2.3 million Facebook Likes), entitled “If You Have Savings In Your 20s, You’re Doing Something Wrong“. The basic premise of the article was that with a long life ahead, 20-somethings shouldn’t fret about not having much of any savings yet, and instead should just spend and enjoy and worry about starting to save later. And while Mr. Money Mustache notes that there is validity to some of the points that the article makes – for instance, that “refusing to give yourself the luxury of enjoying your money negates the whole point of making it” and that “$200/month [of savings] isn’t going to make the dent that a $60,00 pay raise will after spending all those nights out networking” – the biggest opportunity of your 20s is not taking the time for pleasure but taking the time to work. After all, the reality is that our 20s is the point when we often have the most energy, the most capacity (during our working careers) to learn and absorb new information, when we are the most motivated (and not yet cynical) about our opportunities, and a time when many still have the flexibility to work long hours without the demands of children and families (as Millennials are increasingly having kids in their 30s and not their 20s). Moreover, MMM notes that while some people probably do end out getting a huge raise by getting lucky drinking the right mixed drinks with the right influential people at the right moment, it’s a poor strategy for getting ahead; in reality, most people will get ahead by doing hard work that gets results better than anyone else. Business owners have long since learned that business success comes from finding skilled and motivated people and compensating them well… which means the path to success for most is to be that skilled and motivated person that can rise to the top. Of course, that doesn’t mean people shouldn’t pause to have some fun as well, but ultimately the key point is that your 20s is a time to make work the center and enjoy life around it… as that sets you on the best path for income and business growth that will make it easier and easier (financially) to enjoy life even more later, too.
Financial Advice for My New Son (Morgan Housel, Motley Fool) – Popular personal finance writer Morgan Housel recently welcomed his first child into the world, and Housel has taken this as an opportunity to write out a series of 10 advice lessons for his son to read in the future. And not surprisingly, the lessons are applicable to virtually anyone, and include: you might think you want an expensive car, a fancy watch, and a huge house, but what you really want is respect and admiration from others, and having expensive stuff is a poor way to try to get that; financial success (and failure) is often an outcome of the work and effort we put into things, but recognize that luck and chance really do play a material role too (more than we probably care to admit); at some point, it’s good to be poor, because it’s hard to learn the value of money without feeling the power of its scarcity; don’t stay in a job you hate because of a major you chose when you were 18 and didn’t really know what you wanted to do anyway; the best thing money buys is control over your time; using some debt is OK (e.g., for a mortgage), but don’t overuse it, because the road to financial regret is paved with debt (and also commissioned salespeople); and ultimately your savings rate has little to do with how much you earn, and a lot to do with how much you spend, so learning to live with less is the easiest and most efficient way to gain control of your financial future.
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. 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!